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Commercial Real Estate Glossary
Last updated on Nov 25, 2022
2 min read

Special Purpose Entities in Commercial Real Estate

A special purpose entity or single purpose entity (SPE) is a legal entity used to acquire and finance a specific investment while limiting risk for all parties involved.

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In this article:
  1. What is a Special Purpose Entity?
  2. How are Special Purpose Entities Structured?
  3. Related Questions
  4. Get Financing

What is a Special Purpose Entity?

A special purpose entity or single purpose entity (SPE) — also known as a special purpose vehicle (SPV) — is a legal entity used to acquire and finance a specific investment while limiting risk for all parties involved. The main benefit of an SPE is that it is bankruptcy remote, which means that if the firm that owns the entity declares bankruptcy, there is only a limited risk that the SPE will become ensnared in the bankruptcy proceedings. For commercial real estate lenders, this means that a borrower is far more likely to be able to repay their loan, even if they, individually (as an individual person or a company) experience financial trouble.

In addition, the isolated nature of a special purpose entity makes it easier to sell or transfer commercial real estate in the future. Plus, the fact that SPEs are held “off balance sheet” of the parent company, and are legally segregated, can add an additional layer of anonymity for investors and companies who wish to keep their dealings more private.

How are Special Purpose Entities Structured?

SPEs can be structured in a variety of ways, but are most commonly structured as LLCs or LPs. LLCs are usually considered to be the most beneficial for tax purposes. In general, the further an SPE is distanced from its parent company, the safer it will be from bankruptcy proceedings or other financial issues. SPEs can also be used in joint ventures, in which multiple parties will contribute funds to an SPE in order to acquire a real estate investment.

What Types of Commercial Lenders Require Borrowers to Use Special Purpose Entities?

Most commercial real estate lenders, including CMBS lenders, banks, and mezzanine lenders, require borrowers to place their property in an SPE. This is also the case for Fannie Mae®, Freddie Mac® and HUD/FHA multifamily loans.

What are the Tax Benefits of SPEs?

In some situations, holding commercial real estate in a special purpose entity can have significant tax benefits. When disposing of the asset, an investor can simply sell shares in the entity that owns the real estate, instead of directly selling the piece of real estate itself. This can often be beneficial from a tax perspective, as the sale of stock can sometimes be taxed at a lower rate than the sale of real estate.

Related Questions

What is a special purpose entity (SPE) in commercial real estate?

A special purpose entity (SPE) or single purpose entity (SPE) — also known as a special purpose vehicle (SPV) — is a legal entity used to acquire and finance a specific investment while limiting risk for all parties involved. The main benefit of an SPE is that it is bankruptcy remote, which means that if the firm that owns the entity declares bankruptcy, there is only a limited risk that the SPE will become ensnared in the bankruptcy proceedings. For commercial real estate lenders, this means that a borrower is far more likely to be able to repay their loan, even if they, individually (as an individual person or a company) experience financial trouble.

In addition, the isolated nature of a special purpose entity makes it easier to sell or transfer commercial real estate in the future. Plus, the fact that SPEs are held “off balance sheet” of the parent company, and are legally segregated, can add an additional layer of anonymity for investors and companies who wish to keep their dealings more private.

What are the advantages of using a special purpose entity in commercial real estate?

The main advantages of using a special purpose entity (SPE) in commercial real estate are that it is bankruptcy remote, meaning that if the firm that owns the entity declares bankruptcy, there is only a limited risk that the SPE will become ensnared in the bankruptcy proceedings. This makes it easier for commercial real estate lenders to ensure that a borrower is more likely to be able to repay their loan, even if they experience financial trouble.

In addition, the isolated nature of a special purpose entity makes it easier to sell or transfer commercial real estate in the future. Plus, the fact that SPEs are held “off balance sheet” of the parent company, and are legally segregated, can add an additional layer of anonymity for investors and companies who wish to keep their dealings more private.

What are the risks associated with using a special purpose entity in commercial real estate?

The main risk associated with using a special purpose entity (SPE) in commercial real estate is that it may not provide enough financial and legal protection against creditors and other liabilities. SPEs are typically structured as LLCs or LPs, and must state their purpose in their operating statement, as well as provide a series of operating covenants (or rules) which demonstrate how it will isolate itself from any other potentially affiliated entities. However, if these rules are not followed, the SPE may not be able to provide the desired level of protection. Additionally, if the SPE is not distanced enough from its parent company, it may be vulnerable to bankruptcy proceedings or other financial issues.

Sources:

  • www.commercialrealestate.loans/commercial-real-estate-glossary/holding-companies
  • www.commercialrealestate.loans/commercial-real-estate-glossary/special-purpose-entities

What are the legal requirements for setting up a special purpose entity in commercial real estate?

In order to be classified as a single purpose entity, an SPE will need to state its purpose in its operating statement, as well as provide a series of operating covenants (or rules) which demonstrate how it will isolate itself from any other potentially affiliated entities. Common stipulations include:

  • The SPE will have a separate tax identification number (TIN)
  • The entity should have a separate bank account or accounts
  • The SPE cannot guarantee the obligations of other entities (such as using a property held by an SPE as collateral for a separate loan on a different property)
  • The entity cannot mix its assets with those of any other entity

In many cases, such as with CMBS loans, agency loans, and HUD multifamily loans, lenders actually require a borrowing entity to be set up as a special purpose entity. That way, if a borrower or a borrower’s business runs into financial difficulties or declares bankruptcy, their commercial real estate is less likely to be taken by a creditor.

How does a special purpose entity affect the financing of a commercial real estate project?

A special purpose entity (SPE) can have a significant impact on the financing of a commercial real estate project. By isolating the project from the parent company, the SPE can limit the risk of bankruptcy proceedings or other financial issues. This can make it easier for lenders to provide financing, as they know that the project is more likely to be repaid. Additionally, the SPE can provide tax benefits, as the sale of stock can sometimes be taxed at a lower rate than the sale of real estate. Finally, the SPE can provide an additional layer of anonymity for investors and companies who wish to keep their dealings more private.

What are the tax implications of using a special purpose entity in commercial real estate?

The tax implications of using a special purpose entity (SPE) in commercial real estate depend on the type of entity used. Generally, SPEs are used to limit the liability of the owner and to provide tax benefits. For example, if an SPE is set up as a limited liability company (LLC), the LLC will be taxed as a pass-through entity, meaning that the income and losses of the LLC will be passed through to the owners and taxed on their individual tax returns. If the SPE is set up as a corporation, the corporation will be taxed separately from the owners, and the owners will be taxed on any dividends they receive from the corporation.

It is important to note that the tax implications of using an SPE can vary depending on the type of entity used and the specific tax laws in the jurisdiction where the SPE is located. Therefore, it is important to consult with a qualified tax professional to ensure that the SPE is set up in a way that maximizes the tax benefits for the owners.

In this article:
  1. What is a Special Purpose Entity?
  2. How are Special Purpose Entities Structured?
  3. Related questions
  4. Get Financing
Categories
  • Commercial Property Loans
  • CRE Loans
Tags
  • Deed in Lieu
  • Special Purpose Entity
  • Special Purpose Entities
  • Special Purpose Vehicle
  • Single Purpose Entity
  • Single Purpose Entities

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