Tokenizing the THesis Miami — Case Study
Pioneering the Security Token REIT: A Research Report by Mike Lingle at Security Token Advisors
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Nolan Reynolds International (NRI) has over 130 years of history developing and managing commercial real estate properties. Their current portfolio represents over $500 million in properties across the United States and Costa Rica.
Miami has become the center of the crypto universe, at least in the US, so it’s natural that NRI would select the city for the location of their first tokenization project.
In this article we’ll cover:
- Why tokenize the THesis Miami?
- The structure of the deal
- The timeline of the tokenization
- More deal terms
- What’s next?
Why tokenize the THesis Miami?
The number one question that potential investors consistently ask NRI is:
“How can we get our money out earlier if we want to?”
This is because real estate investors are typically locked into deals for years or even decades. Groups of investors have to either all agree to sell together, or individuals in the group have to find people to buy their shares in the private markets. This inefficient process slows the discovery of both new investors and pricing (ie- “How much are my shares currently worth?”), which oftentimes results in a ‘liquidity discount’ for the seller.
The goal of early liquidity has made real estate a successful use case for security tokens. This has the added benefit of opening up these formerly private real estate deals to a broader market of investors who would previously not have been able to participate.
These two drivers — along with NRI’s forward-thinking management team — is what makes tokenization the logical choice for THesis Miami:
- Early liquidity for real estate deals is a common use case that we’re seeing for security tokens. In fact, many of the listed tokens on STOMarket.com represent real estate properties.
- Tokenization effectively democratizes real estate deals, giving primary investors early liquidity plus the ability to sell off portions of positions rather than an “all-or-nothing” ownership model. Secondary investors can then purchase ownership in properties they would never otherwise have access to.
The structure of the deal
NRI is recapitalizing the THesis Miami after successfully opening it during the pandemic, and they project a 9.24% yield:
The property is a newly constructed 770,000 SF expansive mixed-use development comprised of: THesis Residences with 204 residential apartments and a complementing hotel with 245 rooms. Nestled between the ground floor, is an open-air inviting public space surrounded by retail that promotes the live, work, and play themes which radiate throughout the entire community. The residential units are 99% leased as of June 2021 and the Hotel has become a strong partner for the University of Miami in both transient, group, and academic business.
One key point here is that the initial recapitalization is being done as a standard fundraise from accredited investors who are purchasing limited partnership (LP) interests in the operating partnership (called “OP Units”).
NRI is raising $75 million USD from a combination of private placement and up to $35 million USD in crowdfunding via the CrowdStreet platform. There is no tokenization in this first phase, so it looks exactly like a traditional real estate deal at first.
NRI is including the crowdfunding in order to increase the number of shareholders. This will both provide a larger number of potential tokenizers when the time comes, as well as reduce the risk that the REIT’s rules (see below) will be broken in terms of number of shareholders or concentrated ownership. Specifically, the rules state that REITs must:
- Have at least 100 shareholders
- Restrict ownership such that no more than 50% of its shares may be held by five or fewer individuals
The timeline of the tokenization
The tokenization will come later, after a six-month lockup period. NRI is shortening the typical one-year lockup via a private placement under SEC Rule 506(c) followed by registration of the REIT under the Securities Exchange Act of 1934 using Form 10.
On the first day following the lock-up period, existing shareholders will have the option to convert their operating partnership units (“OP Units”) into shares of the REIT, represented by a security token. The operating partnership and the REIT will be bundled into an UPREIT (umbrella partnership real estate investment trust). This UPREIT allows LP owners to exchange their OP Units for shares in the REIT as a tax-free transaction, since they are contributing property to the REIT.
This means that the REIT’s ownership of the operating partnership will grow over time as primary investors convert.
It is these REIT shares that will be digitized into security tokens and traded on the secondary market through one or more licensed exchanges known as Alternative Trading Systems (“ATS”) — such as Securitize Markets, tZERO, or INX.
These security tokens will represent equity interest in the REIT, along with rights to dividends and profit-sharing payments. The tax treatment of the REIT is also different than ownership of the OP Units — so investors who convert will:
- Lose the depreciation benefits (based on a 29-year amortization schedule) of the OP Units that flow through to individual tax returns.
- Gain the preferential tax treatment of the REIT, where long term sales of underlying assets or REIT shares itself may deem certain dividends to be “qualified dividends” and therefore provide more favorable tax rates.
The UPREIT allows OPs to exchange property (OP units) for security tokens that represent shares in the UPREIT. This provides new token holders with participation in the performance of NRI and associated benefits.
It’s important to reiterate that the original OP Units sold in the primary fundraise will not be tokenized. Primary investors benefit because they can:
- Participate in the initial offering and hold OP Units indefinitely to receive both tax benefits and a cash stream, just like they normally would.
- Convert their OP Units into digital securities that represent ownership of an associated REIT, which they can then hold indefinitely to receive a cash stream.
- Sell their digital securities on a secondary market in order to exit some or all of their investment on their own timeline.
It’s also important to note that security token holders (secondary investors) directly participate in the REIT’s performance until such time as they sell. They can hold the security tokens forever if they want, all the while benefiting from the cash flow. Secondary investors benefit because they can:
- Participate in a deal they would not otherwise have access to.
- Hold the REIT security tokens forever if they want, all the while benefiting from the cash flow.
- Sell their digital securities on a secondary market in order to exit their investment on their own timeline.
More deal terms
Distributions
NRI has created a simple waterfall structure where investors receive 100% of distributions from both Net Operating and Capital Event Proceeds up to an 8% return. After that, investors receive 75% of distributions.
Debt Financing
Debt is the biggest part of this deal. But on the debt side, we at Security Token Group have been hearing that some traditional lenders won’t work with crowdfunded properties. Lenders are concerned about capital calls: what happens if the property requires unexpected repairs that the crowdfunded investors aren’t prepared to pay?
NRI has leveraged its long history, proven financial reserves, and business acumen — as well as the way it has structured this deal — to secure debt financing from a well-known lender on reasonable terms.
Capital Calls
NRI has establishing a reserve fund to insulate LP owners from the risk of future capital calls. They have also left open the option of receiving more ownership if they need to contribute more capital. Specifically for the THesis Miami deal they state:
“A reserve fund will be established up front and LP owners will bear no risk of future capital calls. No partner will have the right or obligation to make additional capital contributions to the Operating Partnership other than the general partners in limited circumstances. However, if either general partner were to raise additional capital and contribute it to the Operating Partnership, that general partner will receive additional OP Units, and its percentage interest in the Operating Partnership will be increased in proportion to the amount of such additional capital contributed to the Operating Partnership.”
This protects NRI in rare cases where future capital calls could be larger than the reserve fund.
Governance
Real Estate crowdfunding projects can run into issues where group decision-making slows — or even stops — progress. NRI is retaining full governance of the project, including the right to select the property manager of their choice. This simplifies administration of the property, while still providing financial incentives to the investors. Neither the OP Units nor the security tokens represent voting shares in the governance.
Liquidity
NRI will work with a market maker to provide initial liquidity for the security token. They will also promote the THesis project to a second wave of investors who are interested in purchasing these security tokens. Remember that existing LP owners won’t have to convert all of their shares, which allows a wider range of investors to own smaller stakes in the THesis project. This is how the democratization of finance happens in this case.
What’s next?
NRI has successfully completed the initial fundraise for the THesis Miami. Both the private placement and the crowdfunding portions of the deal are fully-subscribed. We look forward to watching the tokenization in six months.
NRI is also planning to tokenize more properties. Their goal is to allow anyone to invest in any of their deals with the click of a button.
And for all you investors out there, keep your eyes open for this and future security tokens as they list on exchanges like tZERO and Securitize Markets.
Security Token Advisors
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Everything in this report is for informational purposes. Nothing in this report should be taken as financial advice or as an inducement to purchase or sell any security. Nothing in this report should be used as legal advice. Always do your own research before making any decisions regarding financial transactions of securities.
