Derivatives For REITs: Managing Risks And Rewards

In the modern age, public REITs use derivative instruments to manage risk, raise capital and manage their sources and uses of capital based on future commitments. REITs have long used interest rate and foreign exchange (FX) derivatives to hedge or mitigate risks associated with debt obligations or owning and operating properties outside of the U.S. More recently, public REITs have expanded their use of derivatives to raise equity capital with forward share sales, and to protect against dilution in convertible and exchangeable note offerings. In addition, REIT founders and insiders are now able to hedge or monetize their operating partnership (OP) unit holdings with derivative transactions. This article highlights the issues that REITs should consider with respect to derivative transactions, including applicable accounting treatment and tax characterization for purposes of the IRS' REIT qualification tests.