What Is a Propco (Property Company)?
A propco, property company, or prop company is a secondary entity created by a business to hold and manage the real estate that the business owns. Propcos are most often set up as a subsidiary company that exists to hold or own a parent or opco's (operating company) income-generating real estate. The property company owns all of the real estate and related debt, providing the parent or operating company with advantages related to financing and credit rating issues.
Propco arrangements are almost always done to secure more favorable financing for both the propco and the opco. The propco can finance against a much higher amount of its real estate holdings at much more competitive rates, as the bank is making the decision on physical, income-generating assets rather than the more fluid world of business operations valuation. This creates clarity for the financing bank, and in turn, the opco removes the carrying cost of its real estate from its immediate books.
Property companies make financing more clear cut.
Risks of a Propco Arrangement
This type of propco-opco arrangement allows the operating company to rent or lease property from the property company. In practice, this looks like a sale and a leaseback. However, the company never relinquishes the property in any real way, as the propco and opco are part of the same group of companies. While this does sound like the corporate equivalent of having your cake and eating it too, there can be a downside to creating a propco.
If a business works out of multiple locations rather than a primary one, a propco arrangement locks the company into a situation where closing any location becomes more difficult. In a traditional business setup, for example, a company might choose to close an underperforming location or office, and likely sell the property.
By contrast, in a propco arrangement, the propco owns the property and may not choose to sell the property if the market won’t return enough to cover the debts. As a result, the opco may be required to pay rent on a property, even if it is not utilizing it, because the propco depends on that income to service the debt-financed off the properties. In fact, the propco-opco split is usually done to capitalize the overall company for expansion, so companies will often end up with multiple locations through the process.
Propco to REIT Transitions
Because a propco can limit the flexibility of the opco in certain situations, the operating company will sometimes spin the property company off as a real estate investment trust (REIT) to turn it into its own entity. Creating a REIT has tax advantages for the parent company, as it removes any double taxation issues that could arise with a propco-opco arrangement. Once spun-off, the propco can act as any other REIT, adding properties to its portfolio that are unrelated to the opco's business.