What is an Opco?
Opco is the abbreviation for "operating company," typically used when describing the primary operating company involved in an opco/propco deal. In some instances, the operating company spins off a subsidiary as a real estate investment trust (REIT) to gain tax advantages. The property company (propco) maintains ownership of all real estate and related debt, offering the opco advantage related to credit rating and financing issues.
[Important: opco/propco deals are among the most common in forming a REIT.]
An operating company/property company (opco/propco) deal is a business arrangement in which a subsidiary company (i.e. the property company) owns all of the revenue-generating properties instead of the main company (operating company). Opco/propco deals allow all financing and credit rating related issues for both companies to remain separate.
In an opco/propco deal strategy, companies are divided into at least an operating company and a property company. While the property company owns all of the assets – including real estate – that are associated with the generation of revenues, the opco uses the assets to generate sales.
An opco/propco strategy makes it possible for companies to keep certain elements – namely debt and thus debt service obligations, credit ratings and related issues – from the books of the operating company. This typically presents the company with considerable financial advantages and savings. If the operating company creates a REIT for all of its real estate holdings, it can avoid double taxation on all of its income distributions. When credit markets become more constricted, or when property values take a plunge, opco/propco deal strategies are not as practical and in many instances are not even feasible.
- Opco is the abbreviation for "operating company," typically used when describing the primary operating company involved in an opco/propco deal.
- In an opco/propco deal strategy, companies are divided into at least an operating company and a property company.
- There are functional and strategic differences between real estate operating companies and REITs, but REITs do not need to operate the properties.
Real World Example
Casino companies often consider opco/propco restructuring create shareholder value and to streamline operations. The model for this is the 2013 restructuring of Penn National Gaming Inc. The casino company received permission from the U.S. Internal Revenue Service (IRS) to perform a tax-free spinoff of its properties into a new REIT.
Penn National Gaming spun off Gaming and Leisure Properties, transferring all ownership of real estate assets to the newly formed REIT. After completing this spinoff, Gaming and Leisure Properties then leased the properties back to Penn National Gaming.
The special tax rules that exist on Penn National Gaming's REIT prevent the propco from having to pay federal income tax on any rent obtained from the opco. Penn National Gaming's REIT also has a significantly lower interest rate than a gaming company. In addition, because Penn National Gaming eliminated all of the debt related to the property by assigning ownership to its REIT, the opco's lightened balance sheet permits the casino company to borrow the funds it needs to operate and also to dump into further development and expansion of its casinos.
Opcos vs. REITs
There are functional and strategic differences between real estate operating companies and REITs. Many REITs focus their investment and portfolio strategy to generate cash flow through the rent or leases generated by the properties they hold. Investments made by a REIT in a construction project and acquisitions might be aimed at generating rental income from the property. That net income primarily goes towards distributions issued to investors.
A real estate operating company (REOC) might fund new construction and then sell the property for a return. The company could also buy a property, refurbish the building and then resell the real estate for a profit. A REOC could likewise serve as a management company that oversees properties. The earnings that a real estate operating company generates can largely be reinvested in projects such as acquisitions, refurbishments, and new construction. This allows a REOC to fill up its portfolio relatively fast with potential long-term prospects. This compares with the regulations that require REITs to distribute most of their net income to their shareholders. There may be the potential for greater growth prospects with an REOC but they might not generate as much immediate income as REITs.