Why REIT Charters Cap Share Ownership

REIT charters commonly cap individual holdings to support tax qualification through dispersed ownership; charter limits and applicable tax rules vary and change. Each REIT sets its own figure, share class and measure in its charter. Because the same clause stops anyone from accumulating a large block, it also works as a takeover defense.

The ownership test the cap is built to pass

A REIT generally must meet organizational and ownership requirements to maintain its tax status, including limits on ownership concentration; applicable rules vary and change. The closely held test asks whether a handful of individuals control the stock, with shares attributed through entities and related parties. A charter cap is the preventive control for that test.

The cap limits what any one holder may beneficially or constructively own, so the trust does not depend on policing its register after the fact. Many charters void a transfer that would breach the limit, which stops the breach at the moment of sale.

Five holders each sitting exactly at a cap of 9.8 percent would still own less than half of the stock, which is the arithmetic that makes a cap near ten percent workable.

Why the 9.8 percent figure varies from one charter to the next

Most REIT charters carry a cap of 9.8 percent or lower, and the board can grant a waiver. Within that range the drafting differs on the percentage itself, on which share class it covers and on how the holding is measured.

One apartment REIT’s declaration sets the limit at 5 percent of the lesser of the number or value of any outstanding class of common or preferred shares. A healthcare REIT sets 9.0 percent for common stock and 9.9 percent for preferred. Another issuer states 9.8 percent of common shares and 9.8 percent of total stock value, subject to exceptions.

A net lease REIT measures 9.8 percent by value or by number of shares, whichever is more restrictive. For a given holder, that wording selects the higher of two percentages, so the tighter test controls.

A headline figure of 9.8 percent therefore describes a common design. The class, the denominator and the measure sit in the charter text.

“Most REIT charters contain strict ownership limitation provisions, typically capping any single investor at 9.8% or lower unless the board grants a waiver.”

What happens to shares that cross the line

A charter takes one of two routes when a holder would exceed the cap. Some void the transfer that causes the breach. Others move the excess shares to a trust under stated remedies.

Either way, the buyer does not end up holding the excess as ordinary shares.

Constructive ownership counts shares attributed to a holder under the charter’s rules, so a position spread across several accounts can be measured as one position. An ownership calculation for a proposed trade measures the resulting percentage under the charter’s applicable measures, including attributed holdings.

Because the cap holds unless the board grants a waiver, a position above the limit rests on a discretionary board decision.

Worked example: a holder at 9 percent when the issuer repurchases shares

Take a hypothetical REIT with 20,000,000 common shares outstanding at $40 a share, so equity value is $800,000,000. The charter caps any holder at 9.8 percent, measured by whichever of share count or value is more restrictive. With one class and one price, the two measures give the same percentage.

Base case: the cap is 20,000,000 multiplied by 9.8 percent, or 1,960,000 shares, worth $78,400,000. A holder owns 1,800,000 shares, which is 1,800,000 divided by 20,000,000, or 9 percent, worth $72,000,000. The cushion is 1,960,000 minus 1,800,000, or 160,000 shares, worth $6,400,000.

Alternative case: the holder buys nothing, but the issuer repurchases 2,000,000 shares, leaving 18,000,000 outstanding and equity value of $720,000,000. The cap falls to 18,000,000 multiplied by 9.8 percent, or 1,764,000 shares. The same 1,800,000 shares now equal 1,800,000 divided by 18,000,000, or 10 percent. The holder sits 36,000 shares over the cap, worth $1,440,000 at $40.

Same holder, same capital, same price. Only the denominator moved, and the position went from 9 percent to 10 percent. Whether the charter treats that as a breach, and what remedy applies, depends on its wording.

Why the same clause works as a takeover defense

A bidder or activist that wants control has to accumulate stock, and the cap limits how much any one party can hold without a waiver. The clause built for tax qualification therefore also slows a hostile build-up.

An ownership cap can impede a third-party change of control even when the transaction might benefit members or carry a premium. These limits function as antitakeover mechanisms.

Maryland domicile, other takeover defenses, ownership limits and high passive ownership can combine to limit shareholder influence in some public REITs. Since the board holds the waiver, the board sits at the gate for anyone trying to cross the cap.

Mistakes in reading a REIT ownership cap

Treating 9.8 percent as a universal threshold confuses a common drafting choice with the terms of a specific charter. Limits of 5 percent and 9.0 percent both appear, 9.9 percent applies to the preferred stock of at least one issuer, and common and preferred can differ.

Testing one measure leaves a gap. When the charter says whichever is more restrictive, both the share count and the value percentage have to be computed against their own denominators, and the higher one controls.

Using a fixed share count as the cushion ignores that the denominator moves. In the example above, a repurchase of 2,000,000 shares lifts a 9 percent holder to 10 percent with no purchase by the holder.

Reading the clause only as a tax provision misses its governance effect. The same limit restricts how much voting stock one party can assemble and can impede a change of control.

Assuming a waiver is routine overstates what the charter provides. The cap holds unless the board grants a waiver, so a position above it rests on a board decision.

Reading a REIT ownership limit

The charter may count beneficial ownership, constructive ownership or both.

The limit may be set by value, by share count or by whichever is more restrictive. Each wording can produce a different percentage for the same holder.

Different ownership limits can apply to common and preferred classes.

The calculation runs against outstanding shares or value of the specified class.

The charter may void a transfer that would breach the cap or move the excess shares to a trust.

The board holds waiver authority where the charter provides it.

A repurchase shrinks the denominator and moves every holder’s percentage up.

The clause that protects qualification also limits accumulation by a bidder.