Arm’s Length Transactions in Industrial Real Estate
Understanding what an arm’s length transaction is and isn’t is essential to industrial investment.
What Are Arms Length Transactions?
An arm’s length transaction is what an investor usually thinks of in a commercial real estate transaction: It is the sale of an asset from one independent, unrelated party to another. When an industrial investor sells a property to a different commercial real estate investor, this is typically the result.
The opposite of this — let’s say an investor sells a property to his or her family member, or a REIT transfers ownership of an asset from one division to another — is known as a non-arm’s length transaction.
Importance of Arm’s Length Deals
Real estate investors and even lenders rely on arm’s length transactions to determine fair market values for assets. If the buyer and seller of a commercial property are unrelated, it can generally be assumed that — at least in aggregate for a market — parties in most transactions have similar bargaining power and knowledge about the market as well as the properties in particular.
Apart from examining economic trends in a real estate market, there are tax implications to arm’s length sales that are broadly different from non-arm’s length dispositions. These taxes vary depending on the location of an asset — consult your county government’s website to identify transfer tax differences between the two transaction types.
Special Cases
There are times when two related parties may engage in an arm’s length transaction. However, this is generally for asset transfers between different branches of an international organization.
Let’s say a global industrial investor’s German branch wishes to shifts ownership of a Canadian warehouse to its American subsidiary. They will typically pay fair market value from one subsidiary to the other in compliance with international tax law through a practice known as transfer pricing. The Organization for Economic Cooperation and Development provides further guidance on its website.
Related Questions
What is an arm's length transaction in industrial real estate?
An arm's length transaction in industrial real estate is a transaction between two parties who do not have a preexisting familial or business relationship. This is important for lenders, as they may be wary of working with borrowers who are purchasing a commercial property from a relative or business partner. Non-arm's length transactions can also have significant tax implications. Additionally, ethical issues can arise from non-arm's length transactions, such as an employee of a company being threatened with termination or otherwise coerced into purchasing a piece of real estate for (or from) their employer. More information on arm's length transactions in commercial real estate.
What are the benefits of an arm's length transaction in industrial real estate?
The main benefit of an arm's length transaction in industrial real estate is that it can help to protect the interests of both the buyer and the seller. This is because the buyer and seller do not have a preexisting familial or business relationship, which can lead to potential conflicts of interest. Additionally, arm's length transactions can help to protect the interests of lenders, as they may be wary of working with borrowers who are purchasing a commercial property from a relative or business partner. Non-arm's length transactions can also have significant tax implications. (Source)
What are the risks associated with arm's length transactions in industrial real estate?
The risks associated with arm's length transactions in industrial real estate include lenders being wary of working with borrowers who are purchasing a commercial property from a relative or business partner, as well as potential tax implications. Additionally, ethical issues can arise from non-arm's length transactions, such as an employee of a company being threatened with termination or otherwise coerced into purchasing a piece of real estate for (or from) their employer. Source
What are the legal requirements for arm's length transactions in industrial real estate?
Arm's length transactions in industrial real estate are subject to the same legal requirements as arm's length transactions in other types of commercial real estate. Generally, these transactions must be conducted in good faith and without any coercion or undue influence. Additionally, the parties involved must not have any preexisting familial or business relationship. This is to ensure that the transaction is fair and equitable for both parties.
The Securities Exchange Act of 1934 requires that all arm's length transactions be conducted in a manner that is fair and equitable to both parties. Additionally, the Securities Exchange Act of 1934 requires that all arm's length transactions be conducted in a manner that is free from fraud or manipulation.
It is important to note that arm's length transactions are not limited to industrial real estate. They can also apply to other types of commercial real estate, such as office buildings, retail stores, and apartment buildings.
What are the tax implications of arm's length transactions in industrial real estate?
In an arm’s length transaction, the buyer of a product does not have a preexisting familial or business relationship with the seller. This has important consequences when it comes to buying and selling industrial real estate, as lenders may be wary of working with borrowers who are purchasing a commercial property from a relative or business partner. Non-arm's length transactions can also have significant tax implications. For instance, if one party purchases a property from another party, sometimes at a significant discount, they will still generally need to pay property taxes on the full market value of the property. Additionally, attempting to engage in a 1031 exchange with a related party is often more trouble than it’s worth, as the IRS has instituted additional rules involving related-party transactions in order to reduce the potential for tax avoidance.
What are the best practices for arm's length transactions in industrial real estate?
The best practices for arm's length transactions in industrial real estate are to ensure that the buyer and seller do not have a preexisting familial or business relationship. This is important because lenders may be wary of working with borrowers who are purchasing a commercial property from a relative or business partner. Additionally, non-arm's length transactions can have significant tax implications. It is also important to be aware of ethical issues that can arise from non-arm's length transactions, such as an employee being threatened with termination or otherwise coerced into purchasing a piece of real estate for (or from) their employer.
For more information, please see Arm's Length Transactions in Commercial Real Estate.