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.