Opco

What Is an Opco?

Opco is the abbreviation for "operating company," typically used when describing the primary operating company involved in an opco/propco deal, which is the most common structure for spinning off a real estate investment trust (REIT).

The property company (propco) maintains ownership of all real estate and related debt, while the opco conducts day-to-day operations and management, offering the opco advantages related to its credit rating and financing capabilities.

How Does an Opco Work?

An operating company/property company ("opco/propco") deal is a business arrangement in which a subsidiary company (i.e., the property company) owns all of the revenue-generating properties, while the main company (operating company) manages operations without direct property ownership itself. Opco/propco deals allow all financing and credit rating related issues for both companies to remain separate, thus improving each entity's financial position.

In an opco/propco deal strategy, companies are divided into at least one operating company and one property company. While the property company owns all of the assets — including real estate or other property — that are associated with the generation of revenues, the opco is the one that uses the assets to generate sales.

An opco/propco strategy makes it possible for companies to keep certain elements — namely debt and thus debt service obligations, credit ratings, and related issues — off of the books of the operating company. This typically presents the company with considerable financial advantages and savings. If the operating company creates a REIT for all of its real estate holdings, it can avoid double taxation on all of its income distributions. When credit markets become more constricted, or when property values take a plunge, opco/propco deal strategies are not as practical and in many instances are not even feasible.

Example of an Opco

Casino companies, which often function in a sense as entertainment or resort REITS, may consider opco/propco restructuring to create shareholder value and to streamline operations. The model for this is the 2013 restructuring of Penn National Gaming Inc., where the casino company received permission from the U.S. Internal Revenue Service (IRS) to perform a tax-free spinoff of its properties into a new REIT.

Penn National Gaming thus spun off the REIT Gaming and Leisure Properties, transferring all ownership of real estate assets to the newly formed REIT. After completing this spinoff, Gaming and Leisure Properties then leased the properties back to Penn National Gaming who operated them.

The special tax rules that exist on Penn National Gaming's REIT prevent the propco from having to pay federal income tax on any rents obtained from the opco. Penn National Gaming's REIT also has a significantly lower interest rate than a gaming company. In addition, because Penn National Gaming eliminated all of the direct debt related to the property by assigning ownership to its REIT, the opco's lightened balance sheet permits the casino company to borrow the funds it needs to operate and also to dump into further development and expansion of its casinos.

REOCs and REITs

There are functional and strategic differences between real estate operating companies (REOCs) and REITs. Many REITs focus their investment and portfolio strategy to generate cash flow through the rent or leases generated by the properties they hold. Investments made by a REIT in a construction project and acquisitions might be aimed at generating rental income from the property. That net income primarily goes toward distributions issued to investors.

A real estate operating company might fund new construction and then sell the property for a return. The company could also buy a property, refurbish the building, and then resell the real estate for a profit. A REOC could likewise serve as a management company that oversees the properties.

The earnings that a real estate operating company generates can largely be reinvested in projects such as acquisitions, refurbishments, and new construction. This allows a REOC to fill up its portfolio relatively quickly with potential long-term prospects. This can be contrasted with regulations that require REITs to distribute most of their net income to their shareholders as dividends. There may be the potential for greater growth prospects with a REOC but they might not generate as much immediate income as REITs.