What Is Opco (Operating Company)?

The subsidiary created with Opco formation owns all its real estate assets and associated debts and hence is also known as a property company (Propco). However, the operating company is only responsible for managing operations of those properties to generate revenuesRevenuesRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more. The structure is widely popular among real estate companies, investment banks, hospital groups, and hotel chains to ensure long-term financial benefits to both companies.

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How Does Opco/Propco Work? 

The Opco/Propco model provides both companies financial advantages, such as improved credit rating and tax avoidanceTax AvoidanceTax avoidance is the process of reducing the income tax liability of an individual or firm by adopting the lawful methods. The taxpayers can claim exemptions and deductions as allowed under the nation’s tax provisions. Such as investments in municipal bonds and deductions for business loss.read more. This structure is quite common in real estate businesses. It usually entails forming a real estate investment trust (REIT) in which operating company serves as the tenant and Propco serves as the landlord. While the latter leases the spun-off assets back to the former (sale-leaseback), the former pays rent on the latter’s assets.

Key Takeaways

  • Opco (operating company) is a vital component of the Opco/Propco organizational paradigm, with indirect ownership, leasehold, or other interests in assets owned by Propco.Opco sells all of its real estate assets to Propco and proceeds to fund its business development. It then leases back those assets from Propco to carry out its operations.Propco owns all real estate assets and debts, while operating the company holds all other operating assets and manages day-to-day operations of those properties to create money.Two characteristics distinguish REITs from REOCs – tax treatment and government regulations.

The United States Congress first created a REIT in 1960. REITs are companies or trusts that enable investors to invest in real estate holding companies and earn a profit share without owning any property. These are like mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more but with only real estate properties in their portfolio.

Companies with substantial real estate assets have to incur a huge cost on carrying these assets. Many companies convert to a REIT to reduce this liability and free up funds to accelerate their growth. A company has three options to convert to a REIT:

  • Create an Opco/Propco structure wherein the operating company can spin off the property company as a REIT.Use umbrella partnership REIT wherein the company forms an operating partnership through an IPOIPOAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more.Form REIT by converting companies using existing rental income from real estate assets.

Opco/Propco Working Structure

Under the Opco/Propco deal, a company splits into two entities – Opco and Propco. Opco meaning refers to the operating company that holds operating assets and manages all the business operations. It sells all its real estate assets to the property company (Propco) for cash. The operating company uses these funds for business expansion. However, since Opco stills need assets of Propco to carry out its business, it leases back those assets from Propco. In return, the operating company pays a periodical rent per the lease agreement.

Propco uses real estate assets as a security to obtain cheap mortgage loans. It also uses the lease rent received from the operating company to service loansService LoansLoan Servicing is a process in which entities known as loan servicers perform various administrative tasks related to loan repayments on behalf of the lender or loan originator (banks or other financial institutions), such as collecting interest and principal, paying insurance and taxes, and posting statements on a regular basis to the loan borrower in exchange for a predetermined fee.read more. In addition, since Propcos have access to capital, they can use it to advance their real estate business.

A company can opt for an Opco/Propco structure that utilizes real estate investment trust (REIT)Real Estate Investment Trust (REIT)A Real Estate Investment Trust (REIT) is a company that owns and operates real estate properties. Typically REITs are public companies and allow consumers to trade shares in real estate on major stock exchanges.read more for tax benefitsTax BenefitsTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place.read more. Thus, the operating company spins off Propco as a REIT.

Special tax laws govern REITs. As per Internal Revenue Code (IRC), a company must comply with some general requirements to qualify as a REIT. REITs get significant tax benefits on the corporate income tax level. However, they also have to pay an equally important part of their earnings as dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more.

The Opco/Propco model has gained a lot of recognition over the years. It serves as a successful model throughout the world. However, businesses must avoid this structure in the event of a significant drop in property values.

Opco Examples 

Let us look at some Opco/Propco examples to understand the concept better:

Example #1

Suppose a company, Marcus Hotels, operates a hotel chain with 15 hotels. It decides to follow the Opco/Propco model. It will transfer all of its real estate assets to its Propco Comfy Stays.

As per the structure, Marcus Hotels is an operating company holding operational assets and handling all the business operations, while Comfy Stays is a Propco owning of all of Marcus Hotels’ real estate assets.

Marcus Hotels may then lease back those assets to use them to carry on its business and generate income. It is also called sale-leasebackSale-leasebackLeaseback refers to a financial arrangement whereby the company that has sold the asset can take it back on lease from the buyer. Thus, the sale-leaseback facilitates the former owner to utilize the asset while its ownership lies with the purchaser. read more. Comfy Stays gets the lease rent per the lease agreement.

Separating the ownership of different types of assets enables both the companies to ring-fence their finances and focus on their respective operations. Comfy Stays can obtain attractive financing terms and cheaper debt using real estate assets as security. Marcus Hotels, too, can release held-up capital in the real estate for its business expansion. It is a win-win situation for both of them.

Example #2

Hilton Worldwide Holdings Inc. executed the tax-free spin-off of its Park Hotels & Resorts Inc. in 2016. The Park Hotels & Resorts (Opco) spun off the Propco Park Parent as a REIT.

The French hotel company Accor did the same with AccorHotels (Opco) and AccorInvest (Propco). However, AccorInvest was later divestedDivestedDivesting refers to the act of partially or entirely selling organizational assets to generate funds urgently.read more.

The Opco/Propco structure was quite popular during the 2004-2007 real estate boom. It helped companies raise funds through the sale-leaseback approach without losing control over their assets. However, the 2008 global financial crisis2008 Global Financial CrisisThe term “financial crisis” refers to a situation in which the market’s key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more exposed drawbacks of this business structure.

Advantages

Real Estate Operating Company (REOC) vs REIT

REOCs and REITs differ from each other in terms of investment, operation, taxation, and regulation. Let us look at those differences outlined below:

This has been a guide to Opco (Operating Company) and its Meaning. Here we explain how does Opco/Propco work, its structure, along with examples. You may learn more about financing from the following articles –

Opco (operating company) holds indirect ownership, leasehold, or other interests in assets controlled by its direct or indirect subsidiary. It is a critical component of the Opco/Propco organizational model. It can sell all of its revenue-generating assets to a subsidiary and then lease them back to run the company. Opco’s sole responsibility is to manage the properties to earn revenue.

The Opco/Propco arrangement is financially beneficial for both companies in terms of enhanced credit ratings and tax avoidance. It usually involves the creation of a real estate investment trust (REIT), with Opco as the tenant and Propco as the landlord. Real estate businesses, investment banks, medical organizations, and hotel networks all use this structure to assure long-term financial benefits for both parties.

No, a holding company cannot be an Opco. A holding company is the parent company that owns one or more operating companies. It does not engage in operational activities. Instead, the operating companies perform daily business operations and bring in income for it. For example, Citigroup is the holding company while Citibank is the operating company.

  • Zombie CompanyHolding Company (Parent Company)Special Purpose Acquisition Company