REITs and the CFTC

Dodd-Frank’s Title VII is likely to sweep a bunch of private equity fund operators under the CFTC’s registration requirement. The CFTC stated that a single interest rate swap or foreign exchange hedge could drag the fund manager into the definition of “Commodity Pool Operator” (7 USC §1a(10) and have to register with the CFTC. The National Association of Real Estate Investment Trusts was also concerned the equity REITs that use interest rate hedges could be considered a commodity pool.

The CFTC released an interpretative letter releasing REITs from the grasps of the CFTC. The CFTC agrees with the NAREIT position that REITs are operating companies and are therefore not commodity pools.

But will this interpretative letter help real estate private equity funds? Most real estate private equity funds have a REIT somewhere in their structure, so the letter offers some benefit.

The CFTC notes that equity REITs are, in part, operating companies because they engage in substantial management and operational function. (Check for real estate funds.)

Equity REITs use derivatives is limited to supporting its primary focus on real estate ownership and operation. (Check for real estate funds.)

The CFTC list three criteria for this relief:

  • The REIT primarily derives its income from the ownership and management of real estate and uses derivatives for the limited purpose of “mitigat[ing] their exposure to changes in interest rates or fluctuations in currency”;
  • The REIT is operated so as to comply with all of the requirements of a REIT election under the Internal Revenue Code, including 26 U.S.C. §856(c)(2) (the 75 percent test) and 26 U.S.C. §856(c)(3) (the 95 percent test); and
  • The REIT has identified itself as an equity REIT in Item G of its last U.S. income tax return on Form 1120-REIT and continues to qualify as such, or, if the REIT has not yet filed its first tax filing with the Internal Revenue Service, the REIT has stated its intention to do so to its participants and effectuates its stated intention.

I’m not yet sure if this gets a real estate fund all the way out of CFTC registration. I think there will be more to come.