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What Is an Operating Company/Property Company Deal (Opco/Propco)?
Let me explain to you what an operating company/property company (Opco/Propco) deal is. It's a business arrangement where a subsidiary company, which we call the property company or 'Propco,' owns all the revenue-generating properties instead of the main company, known as the operating company or 'Opco.'
These Opco/Propco deals ensure that all financing and credit rating issues for both companies stay separate. You'll see this structure often in real estate deals and when setting up real estate investment trusts (REITs).
Key Takeaways
In these Opco/Propco business arrangements, the subsidiary or Propco holds or owns all the assets and real estate that the main Opco uses to generate revenues. These deals help the parent company by keeping financing and credit terms independent of the operating company.
Beyond loan independence, such deals can offer tax advantages for the parent company. While some view them as tax loopholes, they are completely legal and mark intelligent business practices.
Understanding Operating Company/Property Company Deals (Opco/Propco)
Parent companies can be conglomerates or holding companies. Take a conglomerate like General Electric; it owns companies with different business models alongside its core operations. On the other hand, a holding company exists specifically to hold a group of subsidiaries and doesn't run its own business operations. These holding companies usually form to gain tax advantages.
Master limited partnerships, or MLPs, use a similar parent/subsidiary structure. Most MLPs are publicly traded, and for tax purposes, investors can choose how to receive the income generated by the company.
An MLP has a pass-through tax structure, so all profits and losses go directly to the limited partners. The MLP itself avoids corporate taxes on revenues, escaping the double taxation that hits most corporations. You'll find most MLPs in the energy industry. Subsidiaries own shares—or units—of the parent MLP, and they redistribute the passive income through the corporation as regular dividends.
Criticisms of an Operating Company/Property Company Deal (Opco/Propco)
In Opco-Propco arrangements, the operating company rents or leases property from the property company. In practice, this resembles a sale and leaseback, but the company never truly gives up the property since the Propco and Opco belong to the same group.
This might seem like the best of both worlds, but there are downsides to setting up a Propco. If your business operates from multiple locations rather than one main site, a Propco setup locks you into a less flexible situation where closing any location gets harder.
In a standard business setup, you could close an underperforming location and sell the property. But in a Propco arrangement, the Propco owns the property and might not sell it if the market doesn't cover the debts. As a result, the Opco could end up paying rent on unused property because the Propco relies on that income to service debts financed by the properties.
Example of an Operating Company/Property Company Deal (Opco/Propco)
In the U.K., Opco/Propco deals are a popular way for a parent company to create a REIT. A REIT owns, operates, or finances income-producing real estate, often specializing in sectors like office or healthcare. Generally, REITs pass collected rents to investors as dividends.
You can create a REIT through an Opco/Propco deal by first selling income-generating assets from the Opco to a subsidiary. The subsidiary then leases the property back to the Opco. Afterward, the Opco can spin off the subsidiary as a REIT. The key advantage here is avoiding double taxation on income distributions.
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