A DownREIT is a partnership agreement between a property owner and a real estate investment trust (REIT) in which a property is transferred into a joint venture with the REIT. This is similar in some ways to an UPREIT, which allows property investors to defer capital gains taxes, but there are a few big differences.
What is an UPREIT?
A DownREIT was created as an alternative to the umbrella partnership real estate investment trust, or UPREIT, so it's worthwhile to briefly discuss what an UPREIT is.
Essentially, an UPREIT is an arrangement in which a property investor transfers a property to a REIT's operating partnership in exchange for an interest in the partnership. That interest is given in the form of operating partnership units, or OP units, which are equal in value to REIT shares but cannot readily be sold or cashed in. The OP units rise and fall in price in tandem with REIT shares, and the investor doesn't have to pay capital gains tax on the transferred property until the OP units are sold.
The difference between UPREITs and DownREITs
Unlike "UPREIT," "DownREIT" isn't an acronym for anything in particular. Rather, the name is simply meant to convey that it's an alternative to the UPREIT.
Instead of essentially going into business with an operating partnership, a DownREIT investor forms a joint venture with the REIT itself. The structure of a DownREIT can be quite complicated and can vary considerably from one deal to the next, but the basic concept is that your investment performance continues to depend on your property, not the REIT's entire portfolio. Basically, the investor is given a form of put option that can eventually be converted into REIT shares, but the conversion value is dependent on the particular property's value at the time.
The terms of a DownREIT partnership can become rather complex, and as a result, these types of entities also tend to receive more scrutiny from the IRS. On the positive side, it's possible for a DownREIT to be beneficial if the property in question performs better than the REIT's overall portfolio.
Who should use a DownREIT?
DownREITs can be useful for property investors who want to avoid paying capital gains taxes on the sale of an investment property and who also have reason to believe that their property will significantly outperform the other assets of the REIT. These arrangements are significantly more complex than the more popular UPREIT and are therefore typically used only in situations where their features are extremely likely to be beneficial.