A bevy of businesses want to join the hospitals, self-storage facilities, nursing homes, timberland owners and auto care centers in the wildly prosperous Dow Jones U.S. Specialty REIT Index.
An increasing number of non-traditional companies are applying for REIT status and seeking greater access to the public capital markets.
We’ve already seen more than 10 IPOs for REITs so far this year. In fact, 2013 is poised to be the strongest year for REIT IPOs since 2004, when 29 REITs went public.
Upon reflection, it makes sense that 2013 would be a banner year for REITs. Over the past three years, privately held REITs have been a hot target for institutional investors, and now some shareholders are looking for an exit strategy.
Because REITs pay out 90 percent of their income to their shareholders via dividends, REITs end up paying out roughly 75 percent of their annual cash flow; in turn, this makes many REITs dependent on funding from the capital markets for growth. Being publicly traded also allows REITs to pay off existing debt and borrow from banks under more favorable terms.
Converting to REIT Status
To convert to a REIT, a company must pass an annual income test and quarterly asset tests. Among other regulations, at least 75 percent of the company’s gross income must be derived from real estate-related sources, and at least 75 percent of the company’s assets must consist of real property or debt secured by property.
In 2012 alone, 10 publicly traded companies moved toward REIT conversion. This is a staggering number, especially when you consider that only four publicly traded C-corps converted to REIT status from 2002 through 2011.
To reap tax benefits, non-traditional real estate businesses are getting creative to qualify as REITs. Cell tower owners, private prison operators, billboard companies, funeral homes, data centers and even casinos are applying for REIT conversion. Moreover, these non-traditional REITs are not small players. Cell tower REITs already have a market cap of $31 billion and data center REITs have a market cap of $10 billion.
Sectors once considered to be “specialty,” such as self-storage, health care and timber, are now asset classes unto themselves.
Among the companies shifting to REIT status is Ryman Hospitality Properties Inc., formerly known as Gaylord Entertainment. It owns and operates hotels and attractions. To qualify as a REIT, Ryman sold four Gaylord properties to Marriott. Since January, Ryman has operated as a REIT, with some of its businesses, like the Grand Ole Opry, being run through taxable subsidiaries.
Other planned or completed specialty REITs include:
- Cincinnati Bell Inc. (CyrusOne Inc. data center unit)
- The GEO Group Inc. (prisons)
- Lamar Advertising Co. (billboards)
- Iron Mountain Inc. (document management)
- Equinix Inc. (data centers)
- Crown Castle International Corp. (cell towers)
- SBA Communications Corp. (cell towers)
- Renewable Energy Trust Capital Inc. (solar power generation)
Will all of these companies qualify as REITs?
Yes, assuming shareholders want the companies to convert; the IRS finds that the majority of their income is derived from real estate; and all ancillary income flows through taxable subsidiaries. As an example, timber company Rayonier Inc. became a REIT in 2004. Although Rayonier owns, leases and manages timberland (which is considered real estate), a significant portion of Rayonier’s revenue comes from manufacturing specialty fibers. The fiber division operates through a taxable REIT subsidiary.
No IPOs for self-storage REITS are in the works.
Taxable REIT Subsidiaries
Under the the Work Incentives Improvement Act of 1999, REITs became eligible to generate up to 25 percent of their gross income from ancillary business activities, as long as those activities happen within a taxable REIT subsidiary. The federal law, which includes the REIT Modernization Act, took effect in 2001.
These REIT subsidiaries are subject to income tax, just as if they were C-corps; hence, REITs generally seek rulings from the IRS to ensure that as much income as possible remains at the REIT level rather than at the taxable subsidiary level. These days, the IRS is conducting more audits of transactions between the subsidiaries and their parent REITs.
Ramifications for Self-Storage Operators
Although the self-storage sector has been on a roll, an influx of publicly traded specialty REITs could take some institutional attention away from the storage industry. That could slow down mergers-and-acquisition activity and lower acquisition prices for small storage operators looking to sell.
Grand Ole Opry image courtesy of Nashville Convention & Visitors Corp.