An OpCo PropCo structure is a method by which a company will divide into two parts -- an operating company (OpCo), which owns the operating assets or operating business, and a property company (PropCo), which owns the income-generating assets, such as real estate.
Typically, when a business splits into an OpCo/PropCo structure involving real estate, the OpCo assumes the role of the tenant, making rental payments on the real estate assets to the PropCo, which acts as the landlord and will lease the spun-off assets back to the operating business (known as a sale-leaseback).
The OpCo/PropCo model is quite common in the United Kingdom but has been used quite a bit in the United States as well.
As one recent example, a few years before Sears went bankrupt, the company decided to spin off its real estate assets into a newly-created real estate investment trust (REIT) known as Seritage Growth Properties (NYSE: SRG), which, unlike Sears, is still a publicly-traded stock today. At the time of the spinoff, Sears contributed over 250 properties it owned as well as its interests in several joint ventures.
The transaction gave Sears some much-needed financial flexibility by monetizing its real estate assets and allowed investors who didn't necessarily believe in Sears' business model long-term to put their money to work in the company's real estate assets, which were generally located in excellent locations and had tons of redevelopment potential.
Another example (where both companies are still solvent) is MGM Resorts (NYSE: MGM) and MGM Growth Properties (NYSE: MGP). As most real estate investors know, MGM is one of the largest casino operators in the United States. But what many investors don't know is that MGM doesn't own the buildings in which it operates -- it leases most from PropCo MGM Growth Properties as well as a few other landlords.
Benefits of an OpCo/PropCo structure
There are some good reasons companies that own real estate, but not as their primary business might want to use an OpCo/PropCo strategy. Just to name a few:
Benefits for the OpCo
- Financial flexibility -- Owning real estate is a capital-intensive business model. Many companies (especially those focused on growth) could better use the capital they have tied up in real estate to help fund growth.
- Real estate optionality -- By using a PropCo, an operating company has an advantage when it comes to quickly and efficiently scaling its operations. For example, if the OpCo needs a warehouse, it can be far easier to have an associated PropCo build one than to find a third party to do it.
- Debt reduction -- In most OpCo/PropCo structures, the PropCo takes on much (if not all) of the company's debt. This allows the operating company to enjoy a more capital-light business where it can focus its spending on growing the business as opposed to using profits towards debt repayment.
Benefits for the PropCo
- Built-in tenant -- The PropCo gets the benefit of a built-in tenant for its properties. For example, MGM Growth Properties doesn't need to worry much about its properties going vacant in the same way as most REITs do, because they were specifically put in place to be MGM Resorts' landlord.
- Growth strategies -- As a stand-alone business, a PropCo can pursue growth opportunities that wouldn't be possible and/or practical for a combined operating and property business. Using our MGM example, it wouldn't be a practical business idea for MGM to acquire a casino property operated by another company, but if one were to come on the market at an attractive price, MGM Growth Properties could do that.
- Financing advantages -- A real estate investment trust is a business built for steady, predictable, and growing income, making it an ideal candidate for low-cost financing. In other words, banks are eager to lend money to businesses with a steady and predictable income. On the other hand, a high-growth operating business might be perceived as riskier to lenders. So, spinning off a PropCo can be a great way for a company to gain access to favorable borrowing costs to expand its real estate assets.
On both sides of the equation, splitting into an operating business and property business can allow both sides of the business to focus on what they do best. And as a result, it can make each side of the business easier to evaluate for a prospective investor.
The Millionacres bottom line
An OpCo/PropCo structure can have several advantages over a business that has both an operating business and a portfolio of real estate holdings. While it doesn't make sense in all cases, the OpCo/PropCo model has delivered value for investors and has improved the growth potential of many companies over the years.