What Is an Opco?
Let me explain what an Opco is. It's short for 'operating company,' and it's a key part of the opco/propco deal structure, particularly when you're setting up a real estate investment trust (REIT). In this model, you separate the operations from the property ownership. The opco takes care of the daily management, while the propco holds all the real estate assets. This division gives you strategic financial advantages, better credit ratings, and smoother leasing operations.
Key Takeaways
- An Opco, or operating company, manages daily business operations without direct property ownership in an opco/propco deal.
- In an opco/propco arrangement, the property company owns assets and related debt, separating financial responsibilities from the operating company.
- This strategy can optimize financial performance by improving credit ratings and reducing debt from the operating company's balance sheet.
- Casino companies, like Penn National Gaming Inc., have used opco/propco models to enhance shareholder value and streamline operations.
- The distinction between REOCs and REITs lies in investment and income distribution strategies, with REITs primarily distributing income to investors.
Understanding How an Opco Structure Operates
In an opco/propco deal, a subsidiary owns the revenue-generating properties, while the main company manages the operations without owning those properties. This setup keeps all financing and credit rating issues separate for both entities, which improves their financial positions.
With this strategy, companies split into at least one opco and one propco. The propco owns the revenue-generating assets, and the opco uses them to generate sales.
An opco/propco strategy lets companies keep certain elements—specifically, debt and debt service obligations, credit ratings, and related issues—off the books of the operating company. This often leads to financial benefits and savings. If the operating company creates a REIT for its real estate holdings, it can avoid double taxation on income distributions. But when credit markets tighten or property values drop, these strategies become less practical and sometimes not feasible at all.
Real-World Example: Opco/Propco Strategy in Action
Casino companies, which often operate like entertainment or resort REITs, may use opco/propco restructuring to create shareholder value and streamline operations. Take the 2013 restructuring of Penn National Gaming Inc. as an example. The casino company got permission from the U.S. Internal Revenue Service (IRS) to do a tax-free spinoff of its properties into a new REIT.
Tax rules allow Penn National Gaming's REIT to avoid federal income tax on rents from the opco. After the spinoff, Gaming and Leisure Properties leased the properties back to Penn National Gaming, which continued to operate them.
These special tax rules mean the propco doesn't pay federal income tax on rents from the opco. Penn National Gaming's REIT also has a much lower interest rate than a typical gaming company. Plus, by transferring property ownership to the REIT, the opco removed all direct property-related debt from its balance sheet. This lighter balance sheet lets the casino company borrow funds for operations and invest in further development and expansion of its casinos.
Comparing Real Estate Operating Companies (REOCs) and REITs
There are functional and strategic differences between real estate operating companies (REOCs) and REITs. Many REITs focus on generating cash flow by renting or leasing properties they own. Their investments in construction and acquisitions target rental income, and that net income mostly goes to distributions for investors.
A real estate operating company might fund new construction and then sell the property for a return. It could also buy a property, refurbish it, and resell for a profit. A REOC might even act as a management company overseeing properties.
A real estate operating company can reinvest its earnings in acquisitions, refurbishments, and new construction. This allows a REOC to build its portfolio quickly with long-term prospects. In contrast, regulations require REITs to distribute most of their net income to shareholders as dividends. There may be greater growth potential with a REOC, but it might not generate as much immediate income as REITs.
The Bottom Line
The opco/propco structure provides strategic financial benefits by separating ownership and operational responsibilities, which enhances financial flexibility and can improve credit ratings for the operating company. This is often used in real estate investment trusts (REITs) to avoid double taxation on income distributions. By letting operating companies manage operations without the debt from property ownership, these deals offer significant financial advantages, especially in stable credit markets. However, when credit conditions tighten or property values decline, these strategies may become less feasible. If you're considering this approach, you must weigh the benefits against the potential challenges in different economic climates.
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