Key Takeaways
– “Opco” (operating company) is the business that runs day‑to‑day operations; “Propco” (property company) owns the real estate assets. The opco/propco split separates operations from property ownership to optimize taxes, financing and credit profiles.
– A propco can be structured as a REIT to obtain favorable tax treatment for rents, while the opco operates the business under long‑term leases.
– Benefits include clearer balance sheets, potentially lower cost of capital for property, and tax efficiency; downsides include complexity, regulatory constraints and sensitivity to credit and property markets.
– Use cases: hospitality, casinos, retail, and other asset‑heavy businesses have used this structure (notably Penn National Gaming’s 2013 spinoff that created Gaming and Leisure Properties).
What an “Opco” Means in an Opco/Propco Structure
– Opco = the company that performs the business function: runs hotels, casinos, stores, or management services, employs staff, sells goods or services and generates operating cash flow.
– Propco = the company that holds title to revenue‑producing real estate and leases it to the opco. In many transactions the propco is a REIT (real estate investment trust) or a special‑purpose real estate entity.
– The objective: separate ownership (real estate) and operation (business), so each entity has a clearer risk/credit profile and can be financed according to its asset type.
How the Opco/Propco Model Operates (high level)
1. Establish entities: create at least two legal entities (opco and propco). The propco may be organized to meet REIT rules if tax treatment is a goal.
2. Transfer assets: property titles are transferred (sold or contributed) to the propco.
3. Leaseback: the opco enters long‑term, arm’s‑length leases with the propco for the properties required to run the business.
4. Financial separation: propco carries property‑related debt; opco carries operating debt and working capital financing. Credit ratings and lending terms are evaluated separately.
5. Tax and distribution: if propco is a qualified REIT, it generally pays no federal income tax on qualifying real estate income distributed to shareholders, subject to REIT rules.
Practical steps to implement an opco/propco strategy
Before you start: obtain tax, legal and accounting advice. Actions below are a framework, not a substitute for professional counsel.
1. Define strategic objectives
– Clarify why you want the split: tax efficiency, lower cost of capital, portfolio liquidity, unlocking shareholder value, regulatory reasons, or risk isolation.
– Model financial effects (capital structure, EBITDA, interest coverage, tax payments, dividends).
2. Choose legal structures
– Decide whether propco will be a REIT, a taxable corporation, a partnership, or another form. A REIT has tax advantages but must meet distribution and asset/income tests.
– Create separate boards and governance protocols to preserve arms‑length operations and regulatory compliance.
3. Inventory and value the real estate
– Appraise properties; identify which assets transfer to propco and which remain with opco (if any).
– Consider tax basis and transfer tax consequences of moving title.
4. Transfer assets and document transactions
– Transfer via sale, contribution, or spinoff. If a tax‑free spinoff is intended, ensure transaction structure meets IRS requirements (this often requires advance planning and possibly a private letter ruling).
– Document purchase/sale agreements, shareholder approvals, and regulatory filings.
5. Negotiate leaseback and ancillary contracts
– Create long‑term operating leases with clear terms: duration, rent formula, CPI/escalators, maintenance/repairs, capital expenditure responsibilities, default and cure provisions.
– Establish management and service agreements (e.g., property management, shared services) and intercompany fee arrangements at arm’s length.
6. Finance each entity appropriately
– Propco: secured debt and mortgage financing are typical. Lenders focus on property cash flows and loan‑to‑value ratios.
– Opco: unsecured or subordinated financing, revolving lines for working capital. Opco’s lighter property debt may improve borrowing capacity.
– Coordinate covenants to avoid cross‑defaults disrupting the other entity.
7. Tax planning and compliance
– If creating a REIT: verify REIT qualification tests (75%/95% asset/income rules, 90% distribution requirement, shareholder structure rules).
– Model tax consequences at entity and consolidated levels; consider state tax, transfer taxes and capital gains impact.
8. Corporate governance and operational integration
– Ensure clear governance boundaries (independent directors, audit committees).
– Create dispute resolution protocols and service level agreements for shared functions.
9. Disclosure and investor communications
– Prepare transparent investor reporting showing separate P&Ls, balance sheets, and cash flows. Explain rationale and anticipated benefits/risks.
10. Monitor and adapt
– Track covenant compliance, lease performance, property valuations and market conditions. Be prepared to restructure if market or regulatory environment changes.
Lease design and key contractual terms to negotiate
– Base rent and variable rent: fixed rent vs. rent tied to revenue, EBITDA, or CPI.
– Lease term and renewal options: stability vs. flexibility.
– Maintenance & capital expenditures: who pays for capex? Distinguish between routine maintenance and major capital projects.
– Assignment and transfer restrictions: ability of propco or opco to sell assets or transfer leases.
– Default, cure and remedy provisions: avoid single events that trigger simultaneous defaults across entities.
– Subordination and intercompany guarantees: determine whether opco will guarantee propco debt or vice versa; understand implications.
Tax and regulatory considerations
– REIT requirements: if propco is a REIT, it must meet complex asset, income and distribution tests (e.g., most of its income must be from rents or real property). Failure to qualify can create significant tax costs.
– Transfer taxes and capital gains: transferring property may trigger taxable events.
– Antitrust, securities and state regulatory approval: large spinoffs may require approvals or filings.
– IRS rulings: some structures (e.g., tax‑free spinoffs) may require preclearance or careful compliance to avoid adverse tax results.
Financing, ratings and balance‑sheet effects
– Propco debt: typically secured, lower rates due to collateralized real estate. Propco can often access property‑finance markets (CMBS, mortgage loans).
– Opco credit: with property liabilities removed, opco may improve leverage ratios and credit rating, enabling cheaper operating capital.
– Interdependence: lenders will evaluate lease commitments; opco’s lease obligations may still be a source of credit risk for propco lenders.
Real‑world example: Penn National Gaming (2013)
– Penn National restructured by spinning off real estate into Gaming and Leisure Properties (a REIT), then leasing properties back to the operating company.
– Result: the REIT avoided federal income tax on qualifying rents; the operating company shed property‑related debt, improving its balance sheet and borrowing capacity for expansion.
– This model shows how the structure can create shareholder value when executed with tax rulings and careful documentation [sources: Investopedia summary and business press on the Penn National spinoff].
Comparing Real Estate Operating Companies (REOCs) and REITs
– REITs (propco model) focus on generating rental income from properties and distributing most taxable income to shareholders. REITs are capital‑heavy but provide steady dividends and tax advantages if compliant.
– REOCs (opco model focused on property operations) may develop, refurbish and sell properties for capital gains or manage assets for owners. They typically reinvest profits for growth rather than distributing the majority.
– Tradeoffs: REITs offer stable income and tax efficiency but limited retained earnings for growth; REOCs can pursue higher growth but may generate less immediate income for investors.
When the opco/propco strategy is NOT practical
– Tight credit markets: when financing for either entity dries up or becomes unaffordable.
– Falling property values: propco balance sheets and lenders may be stressed, undermining the strategy.
– Regulatory/tax constraints: inability to meet REIT tests or obtain favorable rulings.
– Transaction costs and complexity outweigh benefits for smaller portfolios.
Risks and pitfalls to watch
– Loss of control over real estate decisions if propco is externally owned or public.
– Tax risk if REIT qualification is lost.
– Contract risk if leases are poorly drafted (hidden liabilities, ambiguous capex responsibilities).
– Correlated risk: operational downturns (opco) can impair rent payments and impact propco’s ability to service debt.
– Related‑party scrutiny: regulators and minority shareholders may challenge transfer pricing or fairness of asset transfers.
Practical checklist before launching an opco/propco split
– Conduct financial feasibility modeling (before and after scenarios).
– Obtain tax and legal opinions regarding transfer, spinoff and REIT qualification.
– Secure valuations and independent fairness opinions if needed.
– Draft and negotiate arm’s‑length lease and service agreements.
– Design capital structures and approach lenders early.
– Establish governance frameworks, board composition and conflict‑of‑interest policies.
– Prepare investor communications and disclosures.
– Run stress tests for property market downturns and tightened credit conditions.
Bottom line
An opco/propco split can be a powerful strategy to separate operating risk from real estate ownership, potentially lowering property financing costs and delivering tax advantages when executed correctly (particularly via a REIT). Its effectiveness depends on careful structuring, robust legal and tax planning, market conditions and disciplined governance. The structure has been used successfully by large hospitality and gaming firms (e.g., Penn National), but it introduces complexity and specific risks that require active management.
Sources and further reading
– Investopedia — “Opco” (overview): https://www.investopedia.com/terms/o/opco.asp
– BusinessWire — Penn National Gaming announcement regarding separation of real estate assets (2013) (press coverage and transaction details)
– Penn National Gaming, Inc. — press materials on formation of Gaming and Leisure Properties, Inc. (2013)
– Lólis, F. Philip; Scott, Mike; Dickinson, Clay. “Consolidating the $50 Billion U.S. Short‑term Rental Market: How PropCos Can Help Best‑in‑Class OpCos Scale and Institutionalize the Asset Class.” Center for Hospitality Research Report, vol. 23, no. 8, August 2023.
If you’d like, I can:
– Outline a sample timeline and transaction checklist for a medium‑sized hospitality company considering an opco/propco spinoff.
– Draft a sample high‑level lease term sheet for an opco/propco arrangement.