1. Reproduced with permission from Real Estate Law & Industry Report, 6 REAL 136, 03/05/2013. Copyright ஽ 2013
by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com
R E I Ts
Addressing Retail Flowback in Listing Transactions for Unlisted REITs
BY SPENCER JOHNSON, TONY ROTHERMEL, AND
KEITH TOWNSEND
1. Overview - the Flowback Issue
U
nlisted real estate investment trusts, or unlisted
REITs, have enjoyed tremendous success raising
and deploying capital into real estate investments.
Unlisted REITs raise capital through public offerings
and make filings under both the Securities Act of 1933
(the ‘‘Securities Act’’) and the Securities Exchange Act
of 1934 (the ‘‘Exchange Act’’) with the Securities and
Exchange Commission as part of their offering process
and ongoing operations. The securities of unlisted RE-
ITs are not (at least initially) traded on any securities
exchange. Investors in unlisted REITs typically consist
of retail investors who acquire the securities through
broker/dealers that market the unlisted REIT’s securi-
ties in connection with its offering process. From a li-
quidity standpoint, an unlisted REIT will generally indi-
cate to investors through its offering process an ex-
pected horizon for the vehicle to seek some type of
liquidity event - whether in the form of a sale transac-
tion, liquidation or an initial public offering or listing
transaction.
A number of unlisted REITs have recently opted to
pursue liquidity for their shareholders through initial
public offering or listing transactions in which the secu-
rities of the vehicle are listed on a national securities ex-
change.1
In some cases, the vehicle itself may issue se-
curities in connection with a capital raising event. In ad-
dition, the shares held by the dispersed, largely retail
shareholder base will become freely tradable. Even a
very small percentage of these existing shareholders
selling into the market following the transaction can
represent significant volume and result in downward
pressure on the stock price. Without the implementa-
tion of appropriate steps, this scenario can result in in-
stitutional investors refusing to participate in the trans-
action or, at best, participating at reduced levels and at
decreased prices relative to what could be achieved
with appropriate measures in place to address this is-
sue. To further exacerbate the issue, the magnitude of
the importance placed by institutional investors on the
issue is unpredictable and may vary from investor to in-
vestor.
2. Alternatives to Address the Flowback Issue
A number of potential alternatives exist to combat
the flowback issue and the pitfalls arising from the re-
tail overhang on the stock. In general, these potential
alternatives can be grouped into three broad categories:
(i) do nothing; (ii) structure a lock-up to control the vol-
1
Piedmont Office Realty Trust, Healthcare Trust of
America, Retail Properties of America, and American Realty
Capital Trust have all closed either initial public offerings or
listing transactions.
COPYRIGHT ஽ 2013 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 1944-9453
Real Estate Law
& Industry Report®

2. ume of flowback; and (iii) enter the market and absorb
a portion of the flowback. The following discussion ad-
dresses each of these potential categories of alterna-
tives and covers specific ideas within each category.
a. Do Nothing. As indicated by the heading, in this
scenario the issuer takes no proactive steps to address
the retail flowback of shares into the market in connec-
tion with the transaction. A review of precedent trans-
actions where this option was implemented highlights
the potential negative implications of the flowback is-
sue. DCT Industrial Trust (DCT), a former unlisted
REIT, conducted an initial public offering and did not
implement any measures designed to address the flow-
back issue. Trading in the stock exerted significant
downward pressure on the share price as retail share-
holders attempted to exit the stock - within four weeks,
the trading volume in the stock exceeded 30 percent of
the number of shares outstanding and within 26 weeks
that number had climbed to more than 150 percent. In
addition, the stock underperformed a peer group of
similar companies by 5 percent to 15 percent during its
first year of trading. Further, the composition of the
ownership of the stock trended significantly from retail
to institutional holders during the initial trading year of
the stock indicating that the full demand for the stock
from institutional investors may not have been captured
in connection with the initial public offering. Following
its listing, approximately 25 percent of the stock was
held by institutional investors —at the end of its first
year of trading, that figure had increased to approxi-
mately 80 percent. Inland Real Estate Corp. (IRC) took
a similar approach in connection with its listing trans-
action (i.e., the listing of the stock without any corre-
sponding primary offering). Similar to DCT, Inland ex-
perienced significant volume. Within four weeks the
trading volume in the stock exceeded 20 percent of the
number of shares outstanding and within 26 weeks over
60 percent of the outstanding shares had changed
hands. While Inland outperformed its peer group, its
ownership also trended from retail to institutional with
just over 6 percent being held by institutions immedi-
ately following the transaction to approximately 35 per-
cent within one year of the transaction.
DCT and Inland provide important data points for un-
listed REITs considering taking no action to address the
flowback issue in connection with a listing transaction
or an initial public offering. The trading volumes for
these two companies show significant volume, increas-
ing price pressure on the stock during extended time
periods following the transaction. As an initial consid-
eration, investment banks prefer for the trading mar-
kets following an initial offering of a security to free of
pricing pressure caused by trading by existing security-
holders. Unlisted REITs pursuing listing transactions
may be unable to find investment banks willing to par-
ticipate in an offering in which no action is taken to ad-
dress the volume and price pressure associated with the
flowback. Further, each of these precedent transactions
shows strong institutional interest in the stock as insti-
tutions trade into the security over the initial year of its
listing. Although difficult to quantify, issuers would
have to consider how much of that demand could have
been harnessed to increase price and participation for
the security in connection with the issuer’s primary of-
fering. At a minimum, pricing in connection with the of-
fering will be negatively impacted based on institutional
investor concerns regarding the flowback issue.
b. Control the Flowback - Implementing Lock-Ups. The
flowback issue has its origins in the scope and charac-
ter of the unlisted REIT shareholder base. The unlisted
REIT shareholder base is largely dispersed and made
up of retail holders that, individually, do not generally
own any meaningful position in the security. For a more
traditional private company pursuing an initial public
offering, the clean trading market post-closing in re-
spect of existing shareholders (as required by invest-
ment bankers) is typically handled through a customary
lock-up agreement. The group of potential options to
address the flowback issue outlined below are intended
to moderate the degree of flowback just as lock-ups are
imposed in connection with more traditional initial pub-
lic offerings.
i. Traditional Lock-Ups.
The idea of implanting a traditional lock-up with ex-
isting shareholders of unlisted REITs would effectively
require the unlisted REIT to solicit each shareholder to
sign and return a lock-up agreement in connection with
the listing transaction. While effective from a legal per-
spective with respect to any shareholder that returns
the lock-up, this approach is unlikely to be successful
for a number of reasons. Most importantly, there is no
real economic incentive for the shareholders to return
the lock-up. From a more practical perspective, this
process would require the issuer to print and mail thou-
sands of lock-up agreements to existing shareholders,
expend the resources to follow up with those sharehold-
ers regarding completing the materials and spend
countless hours inventorying, reviewing and assimilat-
ing the lock-ups. We are not aware of any unlisted REIT
pursuing this approach in connection with an initial
public offering or listing transaction and do not view it
as a viable alternative to addressing the flowback issue
given the economic and practical considerations in-
volved with this approach.
ii. Recapitalization in Connection With a Listing
Transaction.
The recapitalization option for installing a lock-up
mechanism in connection with a listing transaction has
become the preferred answer to the retail flowback is-
sue for unlisted REITs. The recapitalization option con-
verts existing common shares of the unlisted REIT into
a new class of stock that is not listed as part of the
transaction. The initial public offering or listing trans-
action then lists a new, separate class of stock on the
relevant exchange. The new shares obtained by the ex-
isting holders in connection with the transaction then
convert into the listed security over a staggered period
of time. Generally, the unlisted security is divided into
three separate tranches that convert to the listed secu-
rity in equal installments over the 60-, 120-, and 180-day
periods following the closing of the transaction. The re-
capitalization event is appealing in connection with list-
ing transactions as it moderates the amount of flowback
on a wide-spread basis across the entire shareholder
base of the unlisted REIT. Further, by controlling the
volume of flowback, the recapitalization option encour-
ages institutional investor participation in the transac-
tion by eliminating the element of downward price
pressure on the security immediately following the
transaction from retail flowback.
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3-5-13 COPYRIGHT ஽ 2013 BY THE BUREAU OF NATIONAL AFFAIRS, INC. REAL ISSN 1944-9453

3. While the recapitalization option is attractive given
its effectiveness in addressing the flowback issue, the
recapitalization option is not without cost and timing
implications for the overall transaction. As the process
to implement the recapitalization requires an amend-
ment to the issuer’s charter, the unlisted REIT will be
required to seek and obtain shareholder approval. This
process will require the issuer to prepare and file with
the Securities and Exchange Commission (SEC) proxy
materials in connection with obtaining the shareholder
vote. The SEC will have an initial period of 10 calendar
days to notify the issuer as to whether it intends to re-
view the proxy materials. If no notice is given, the is-
suer may proceed with the proxy solicitation. Given the
materiality of the recapitalization and the focus on un-
listed REITs by regulatory authorities, issuers should
generally expect the SEC to review the proxy filings,
which most likely means a minimum of 60 calendar
days between the date the initial filing is made and the
date of the shareholders’ meeting to approve the recapi-
talization. The requirement for a shareholder vote will
need to be taken into account in connection with struc-
turing listing transactions and shaping expectations re-
garding timing. The shareholder vote requirement and
related proxy materials will also increase the cost asso-
ciated with the transaction.
c. Absorb the Flowback - Offset Opportunities. In addi-
tion to structural mechanisms to control the flowback,
there are a number of alternatives available to unlisted
REITs to absorb some portion of the flowback in an ef-
fort to eliminate the volume of shares entering the mar-
ket on a post-transaction basis. While these alternatives
may be sufficient to eliminate some portion of the flow-
back, by their nature they are unlikely to be sufficient
in size or scope to completely address the issue. Rather,
each of these options acts as a mitigant in reducing the
amount of pressure on the security from a volume and
pricing perspective. In general, this group of alterna-
tives can be broken into two general categories—
permitting investors to participate in the initial public
offering and the issuer entering the market on a post-
transaction basis to acquire shares of the listed security.
i. Selling Shareholders in the Initial Public Offer-
ing.
The unlisted REIT may consider permitting existing
members of the retail shareholder base to participate in
the offering. This approach addresses the flowback is-
sue by redirecting a portion of the flowback directly
into the public offering and alleviates the overhang
caused by potential post-transaction sales of those
shares by the existing holders. It is not unusual for
some portion of the existing shareholders of a company
to monetize a percentage of their holdings in connec-
tion with an initial listing of a company’s securities.
However, this process is not particularly attractive for
unlisted REITs primarily for the same reasons that drive
the flowback issue itself. The widespread nature and
the retail character of the typical unlisted REIT share-
holder base makes the potential for allowing existing
shareholders to participate in the offering impractical.
To participate in the offering, shareholders would be
required to deliver a commitment to participate in the
offering, together with relevant transfer instruments in
respect of their holdings, in advance of the offering.
This would mean coordinating a mailing of the docu-
mentation to each shareholder and the return of com-
pleted documentation by shareholders wishing to par-
ticipate in the offering. Given the relatively small posi-
tions held by individual investors, the unlisted REIT
would need to expend significant time and energy in
connection with this process for the participation of the
shareholders in the offering to provide any meaningful
solution to the flowback issue. The process for prepar-
ing the relevant documentation, distributing it to share-
holders, following up with shareholders and coordinat-
ing participation in the offering in general may also sig-
nificantly add to the cost and time required to close the
transaction.
Trading in the stock exerted significant downward
pressure on the share price as retail shareholders
attempted to exit the stock - within four weeks,
the trading volume in the stock exceeded 30
percent of the number of shares outstanding and
within 26 weeks that number had climbed to more
than 150 percent.
Beyond the logistical limitations, the size and scope
of this potential alternative will be limited by economic
considerations as well. The book of purchasers in con-
nection with the initial public offering are likely to man-
date through their interest and pricing levels that a sig-
nificant portion of the trade be made up of a primary of-
fering by the issuer. As initial public offerings tend to be
sold on a growth strategy, the growth potential and op-
portunities for the issuer diminish as the amount of
capital from the transaction trends away from the is-
suer. In other words, the initial public offering growth
story can be undercut if the selling shareholder partici-
pation represents a material portion of the transaction.
This potential negative pricing impact should be ex-
plored with the issuer’s financial adviser and taken into
account when attempting to counterbalance the poten-
tial upside from addressing the flowback issue.
ii. Issuer Enters the Market to Address Flowback.
Perhaps the most interesting set of alternatives for
the unlisted REIT in addressing flowback issues is en-
tering the market as a buyer to purchase some portion
of the flowback entering the market. There are a num-
ber of considerations relevant to the unlisted REIT in
making the determination to move forward with this
option. In general, these considerations can be grouped
into two separate categories: (a) legal and timing con-
siderations relative to the repurchasing program to be
implemented and (b) the form of the repurchasing pro-
gram to be implemented. As the legal and timing impli-
cations are the threshold question regarding when the
issuer may enter the market and, in some instances,
dictates the size of the program, this article addresses
these considerations first.
Legal Considerations. As a threshold item, Regulation
M under the Securities Act governs the activities of dis-
tribution participants in a public offering of securities.
Specifically, Regulation M precludes manipulative con-
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4. duct by persons with an interest in the outcome of an
offering. Among other things, Regulation M prohibits
issuers, selling security holders, underwriters, broker-
dealers, and other distribution participants from di-
rectly or indirectly bidding for, purchasing, or attempt-
ing to induce any person to bid for or purchase any se-
curity that is the subject of the distribution during the
applicable restricted period. Consequently, the unlisted
REIT pursuing a listing transaction should be aware
that it would be prohibited from entering the market for
purposes of absorbing flowback until the distribution
associated with the offering is complete. For these pur-
poses, the distribution will be complete once the under-
writing syndicate has broken.
In addition, Rule 10b-18 promulgated under the Ex-
change Act provides an issuer with a non-exclusive safe
harbor from liability under certain market manipulation
rules under the Exchange Act as well as Rule 10b-5 un-
der the Exchange Act. Rule 10b-18’s safe harbor is
available when repurchases of the issuer’s common
stock in the market are made in accordance with the
rule’s manner, timing, price, and volume conditions.
Rule 10b-18’s safe harbor is available for purchases of
the issuer’s stock on any given day. Failure to meet any
one of the four conditions will disqualify all of the issu-
er’s repurchases from the safe harbor for that day. Rule
10b-18 permits purchases of up to 25 percent of daily
volume based on average volume for the trailing four
calendar weeks preceding the week of the purchase. An
issuer cannot rely on 10b-18 for purposes of coming
within the safe harbor provided by the rule until the is-
suer’s security has been publicly traded for at least four
completed calendar weeks. Issuers generally will not
purchase in the market until the safe harbor is available
and, as a consequence, remain out of the market for at
least this designated period following the closing of the
transaction.
Finally, the prospectus and related disclosure pack-
age in connection with the issuer’s listing or initial pub-
lic offering transaction should include detailed disclo-
sures regarding the issuer’s intended approach to stock
repurchases. Given that the issuer would be entering
the market a relatively short period of time following
the offering, a heightened level of transparency and dis-
closure is of critical importance relative to setting ex-
pectations of investors in the transaction. In particular,
the expectations regarding the sources and uses of pro-
ceeds should be disclosed in the prospectus.
Implementing Share Buy-Backs. The issuer has a num-
ber of alternatives available in connection with imple-
menting the share buy-back process to mitigate the im-
pact of the retail flowback. Specifically, the issuer may
enter the market directly through direct market pur-
chases, implement a so-called 10b-5-1 program where
the purchases are placed through a broker under a de-
fined set of criteria, or have one more intermediaries
conduct open-market purchases on the issuer’s behalf.
To the extent that these open-market purchases are not
significant enough to mitigate or impact the negative
implications of the retail flowback, other more signifi-
cant alternatives are available to the issuer. For ex-
ample, the issuer may determine to launch a public ten-
der offer for a designated number or dollar amount of
its outstanding shares. In addition to the manner of the
repurchases, the issuer will also need to separately con-
sider how the repurchases will be funded. Depending
on the relative size of the repurchase activity, the issuer
may rely simply on cash-on-hand or need to pursue a
credit facility or other leverage to implement the buy-
back. The structure, timing, and manner of implement-
ing share repurchases should be discussed with counsel
in connection with the pursuit of the listing or initial
public offering transaction and taken into account in
the issuer’s disclosure.
Conclusion. Unlisted REITs pursuing a listing trans-
action should consider the potential implications asso-
ciated with the retail flowback issue. A number of op-
tions are available to mitigate the risks associated with
this issue. Unlisted REITs should consult with their le-
gal and financial advisers regarding the most appropri-
ate strategy to address the retail flowback issue based
on the vehicle’s individual facts and circumstances.
Spencer Johnson is a partner in King & Spald-
ing’s Atlanta office and a member of the
firm’s Capital Transactions and Real Estate Prac-
tice Group. Tony Rothermel is a partner in King
& Spalding’s New York office and a member of
the firm’s Capital Transactions and Real Estate
Practice Group. Keith Townsend is a partner
in King & Spalding’s Atlanta office and a mem-
ber of the firm’s Corporate Practice Group.
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3-5-13 COPYRIGHT ஽ 2013 BY THE BUREAU OF NATIONAL AFFAIRS, INC. REAL ISSN 1944-9453