SPACs and Real Estate

It seems that not a day goes by when we are not asked whether a special purpose acquisition company, or SPAC, can be suitable for acquiring and taking public a real estate portfolio. We hope that the following Q&A will help our clients and friends to get ahead of the topic. Capital markets opportunities tend to be fleeting. The market conditions giving rise to this Q&A may not endure. We believe that as regards real estate SPACs, early movers will have an advantage.

What is a SPAC?

In its simplest form, a SPAC is a shell company that raises capital in the public markets with the sole intention of finding and merging with a target operating company.[1]

Similar to a “blind pool” structure in the non-traded REIT space, a SPAC goes public without having identified any specific target to acquire. Instead of analyzing the assets of the SPAC—since the assets, post-IPO, consist almost entirely of cash—investors make their investment decision by evaluating the strength of the sponsor and its likelihood of consummating a compelling acquisition.

What is behind the recent SPAC trend?

SPACs were in vogue in the 1990s and again in the late 2000s, and have made a significant comeback in the past three years. This rise in SPAC activity is coming at a time of an elevated level of “dry powder,” or cash available for investment, in the private equity markets. As with capital always and everywhere, that dry powder is looking for deals.

Why would a company decide to merge with or be acquired by a SPAC?

For the target company, including the owner of a real estate portfolio, SPACs provide a relatively easier way to go public, at a greater speed than through a traditional underwritten IPO or a direct listing, with less of a window for pricing volatility before the initial trade date. As with a public offering, the target company gains access to a pool of capital to permit the existing owners to exit and/or to fund operations or growth of the business. Unlike with an IPO, financial projections for the target company may be included in the SPAC’s proxy statement for the business combination.

Additionally, the target company has an ally in the sponsor of the SPAC. While the target company and the SPAC sponsor are adverse to each other in the M&A deal, negotiating over pricing and other terms, their interests are aligned as far as educating the SPAC’s investors (who may have approval rights over the transaction and likely have redemption rights in connection with the transaction) on the proposed merger and shepherding the combined company to a successful listing. In fact, the sponsor’s compensation is directly tied to the success of the combined company.

How do SPACs benefit investors?

For the investor, SPACs provide early access to private companies, including real estate portfolios and assets, with the benefits of owning shares in a publicly traded company. Of course, private deals can provide exceptional benefits to investors. But public capital provides its own benefits too. SEC Commissioner Allison Herren Lee listed some of them when, in a recent speech, she singled out SPACs as a promising recent development for going public.[2] The benefits that she noted, and others, include:

• the ability to co-invest alongside the sponsor management and, in some cases, the target management;
• the liquidity that comes from investing in a publicly traded entity;
• owning shares in a company subject to robust registration, reporting, information and auditing requirements;
• potential for attractive risk-adjusted returns over time; and
• downside protection in the event a business combination transaction does not take place.

How does the sponsor benefit?

For a real estate sponsor, the SPAC structure can be used as an asset management play. Real estate sponsors should view a SPAC as an alternative to raising a private fund, a publicly traded REIT or a non-traded REIT. The most successful sponsors of SPACs targeted toward other industries have typically raised hundreds of millions of dollars of equity capital through their SPACs. In fact, the largest SPAC ever to go public, Pershing Square Tontine, raised $4 billion. Prospective sponsors need to understand that this capital is not raised incrementally, over months and years, but all at once, through a fully underwritten IPO.

In terms of compensation to sponsors, one of the main incentives is this: sponsors of a SPAC generally receive founder shares that ultimately represent 20% of the SPAC’s issued and outstanding shares post-IPO. This equity stake can have substantial value after the completion of a successful acquisition. When designed correctly, the sponsor’s compensation structure aligns its interests closely with those of the SPAC’s investors and the owners of the target company.

Many successful SPAC sponsors have been able to launch multiple SPACs, repeating the process each time with a different target asset.

Can a SPAC acquire real estate?

Yes. Historically, SPACs have targeted high-growth companies that otherwise might have been candidates for a middle-market IPO. Recent deals have shone a spotlight on the synergies between real estate-related targets and SPACs, with multiple SPACs expressing an intention to acquire PropTech targets. A recent example is the acquisition of real estate startup Opendoor by Social Capital Hedosophia Holdings Corp. II. But real estate more generally—both the dirt and the secured loans thereon, in multiple property sectors—can be an appropriate, and possibly an optimal, target. As the following bullet points show, real estate SPACs may be a new opportunity for capital-raising and transactions in the real estate industry.

What are some examples of SPACs that have acquired, or have stated an intention to acquire, a traditional real estate-related business?

Here are some recent examples:

• Equity Distribution Acquisition Corp. This $360 million SPAC, co-founded by Sam Zell, went public on September 15, 2020, and intends to target companies providing technology-enabled solutions in industrial and industrial distribution markets. While keeping the SPAC’s options open, including with respect to PropTech investments, the prospectus implies a keen interest in the distribution centers themselves.

• DiamondPeak Holdings Corp. This $250 million SPAC went public in February 2019, expressing an intention to focus its search on a target with a real estate-related component. Interestingly, on October 23, 2020, the SPAC announced the closing of its merger with Lordstown Motors Corp., an Ohio-based electric pickup truck manufacturer. The manufacturer owns a 785-acre, 6.2 million-square-foot assembly plant, formerly owned by GM, which will be retrofitted for electric vehicles with some of the SPAC proceeds. In this case, the acquired industrial facility provides the real estate-related component. The shares of the SPAC, and now of the combined company, have traded substantially higher since the announcement of the acquisition on August 3, 2020.  

• Pace Holdings Corp. This $400 million SPAC, led by David Bonderman of TPG Capital, went public in 2015. The prospectus did not imply any strategy having to do with real estate. Nevertheless, in March 2017, the SPAC merged with Playa Hotels & Resorts, a Netherlands-based owner, operator and developer of all-inclusive resorts in Mexico and the Caribbean.

• Trinity Merger Corp. This $300 million SPAC went public in 2018, stating an expectation to focus on acquiring a company with a real estate component. In November 2019, the SPAC merged with Broadmark Realty Capital Inc., which is now an internally managed REIT that provides secured financing to real estate investors and developers.
• Gores Holdings IV, Inc. This $400 million SPAC went public in January 2020 and, as with Pace Holdings Corp. (mentioned above), its prospectus did not imply any strategy focusing on real estate. On September 23, 2020, the SPAC announced a proposed merger with United Wholesale Mortgage, the largest wholesale residential mortgage lender in the United States.

• Big Rock Partners Acquisition Corp. This $60 million SPAC went public in 2017, disclosing an intention to focus its search on identifying a target in the senior housing industry. As of this writing, it is still searching for an appropriate target while evaluating the impact of the COVID-19 pandemic on the senior housing industry.

What real estate asset classes best lend themselves to a SPAC transaction?

As noted above, we have seen SPACs acquire, or express an intent to explore acquiring, real estate targets in the distribution center, industrial, vacation resort, mortgage financing, senior housing and PropTech spaces.

If you were to ask us what the above targets have in common, they are pure-play and growth-oriented and, in a few cases, involve a significant tech component. Sponsors considering a real estate-focused SPAC should keep these three prongs in mind when drafting their offering documents and selecting potential targets.

Asset classes where we haven’t yet seen activity from real estate SPACs, but that seem ripe for a real estate/tech play, include data centers and wireless towers, those real estate-based backbones of the online economy. Cold storage, critical for the distribution of the eventual COVID-19 vaccine, seems like another key contender.

How does a SPAC solve a real estate company’s need for liquidity?

Real estate is the archetypal illiquid asset. A private real estate company might enable its owners to obtain liquidity through cash-out financings, whether secured by assets or unsecured, and whether company-wide or asset- or portfolio-specific, and through dispositions of assets (subject to dealer limitations on dispositions in the case of a REIT). By combining their private company with a SPAC, the owners generally cause their ownership interests to become tradeable on the NASDAQ or the NYSE, as applicable, providing a measure of liquidity, subject to any lockup agreements that they might enter into as part of the transaction. However, in some circumstances, in a variation on an Up-C structure for tax-deferral purposes, the SPAC transaction may be structured to permit the owners of the target company to hold partnership units in a subsidiary of the public company that would be exchangeable in the future for freely tradeable shares of the parent public company.

Does owning real estate assets through a SPAC impact the tax treatment to the investors?

Yes, it may. Real estate is typically owned through pass-through vehicles in order to avoid a separate corporate-level tax and to pass through losses and deductions to investors. Those benefits are generally lost when investing in a SPAC which, subject to the discussion of REITs below, is treated as a corporation for federal income tax purposes.

Can a real estate-focused SPAC be organized as a REIT?

Yes, a SPAC can be organized to qualify as a REIT. However, in addition to making a REIT election, an entity must meet strict tests relating to the type of assets it holds, the type of income it earns and its ownership structure in order to qualify as a REIT. Because in general a REIT must not be closely held and must hold a real estate portfolio, a SPAC that otherwise expects to satisfy these requirements may not be able to qualify or elect REIT status from the date of its inception.  

After acquiring a real estate portfolio, can a SPAC elect to be treated as a REIT?

Yes. If the newly combined company will meet the REIT requirements, then it may elect to be taxed as a REIT. REIT benefits include the ability for the REIT to reduce its taxable income by distributing the income to its shareholders, effectively eliminating the “second layer” of tax ordinarily arising at the corporate level. While distributions to REIT shareholders are generally treated as dividends, and those dividends may be taxed at higher rates than dividends from a regular C-corporation, the overall tax benefit of operating as a REIT makes it very attractive to potential SPAC investors. 

A REIT election can greatly facilitate market access. Public REITs have existed since the 1960s. They are well understood by investors and attract substantial analyst coverage. There is ample precedent for REITs of virtually every commercial and residential real estate asset class, including mortgages. A SPAC sponsor targeting real estate should at least consider using a REIT structure, even if a different tax classification is chosen in the end.

Can a SPAC acquire the assets of a private REIT?

Yes. A SPAC can acquire the assets of a private REIT and, if the SPAC independently satisfies the REIT requirements, become a publicly traded REIT. The country is full of private REITs, with many open to exploring a transaction.