Firms Restructure as REITs

Firms Restructure as REITs

Faced with limited investment opportunities as the global economy slows, a growing number of companies are weighing changing their entire corporate structure to become real-estate investment trusts.

By becoming REITs—corporations engaged mainly in owning and operating real estate—they can return excess cash to shareholders, while avoiding federal income taxes, and get a chance to boost their stock market valuations, which has led some investors to push for the change. Also helping the trend: a broader definition by the Internal Revenue Service of the types of assets that qualify for REIT conversion.

The conversion process, however, can be complex, expensive and time consuming. For example, Iron Mountain Inc. expects that it will take 18 months and roughly $375 million for it to make the switch by Jan. 1, 2014. The data-storage company, which operates 64 million square feet of real estate, expects to distribute between $1 billion and $1.5 billion to shareholders as part of the conversion, with a “significant” amount of that being paid by the end of this year.

Among the companies currently considering a switch are data-center operator Equinix Inc. and prison operator Corrections Corporation of America. Gaylord Entertainment Co., which owns and operates conference resorts, said in May that it will make the conversion.

In June, Iron Mountain’s board approved a plan to pursue a conversion to a REIT. That decision came about 15 months after one of the company’s shareholders, hedge-fund manager Elliott Management Corp., began agitating it to do so.

Richard Reese, Iron Mountain’s chief executive, said the decision followed a yearlong study that concluded it was no longer a growth company.

“We will have more excess cash flow than reinvestment opportunities,” at the stage the company is in now, Mr. Reese said in an interview. Stephen Golden, vice president of investor relations, said Iron Mountain had $663.5 million of cash flow from continuing operations last year and invested $209.1 million on capital expenditures.

REITs don’t pay corporate income tax on any earnings distributed to shareholders, as long as those distributions total at least 90% of earnings. Shareholders pay regular income taxes on those dividends.

Although there are no data on how many companies have converted to REITs, investors have shown an appetite for the trusts. According to Dealogic, equity REITs, which invest in physical properties, as opposed to mortgage securities, have raised $12.1 billion this year as of Aug. 3. That’s on pace to beat the $16.3 billion raised last year, and slightly below the $20.1 billion raised in 2010, the most raised since at least 1995, as far back as Dealogic’s data go.

Shares in REITs have also performed well, which has encouraged firms that want to boost their share price to pursue conversion, according to tax expert Robert Willens.

According to the National Association of Real Estate Investment Trusts, U.S. equity REIT shares returned 17.9% through Aug. 3 this year, compared with the S&P 500′s 12% return. Last year, equity REITs returned 8.3%, compared with 2.1% for the broader stock index.

Another reason for increased interest is that the IRS has broadened assets that can qualify for REIT status, Mr. Willens said. The IRS recently ruled that billboards could be considered real-estate assets and has over the past few years also deemed solar panels and shelving units as acceptable property for REIT conversion.

The IRS said in a statement that it has used the same standards to identify qualifying assets for many years. “Sometimes newly developed assets meet those standards, but the approval of specific assets in new cases should not be confused with a relaxation of the standards themselves.”

Despite the appeal, few will be able to comply with the stringent conversion requirements, said Reuben Daniels, managing partner of EA Markets, an investment bank that is advising Iron Mountain on its conversion.

Under U.S. rules, companies are only eligible to become REITs if at least 75% of their assets and 75% of their gross income comes from owning and operating real estate. That means companies may need to make changes to meet that standard.

Gaylord Entertainment, for example, will sell its brand and management operations to Marriott International Inc. before converting to a REIT.

Making the switch took Weyerhaeuser Corp. 18 months, said Patricia Bedient, the timber company’s chief financial officer. Weyerhaeuser became a REIT in 2010 to remain competitive with rivals such as Plum Creek Timber Co. and Potlatch Corp., which are both REITs, she said. It had to go through more than 100 years of tax filings to calculate how much it had earned since its founding in 1900. It then distributed $5.6 billion to shareholders in cash and stock before becoming a REIT.

EA Markets’ Mr. Daniels said recent IRS rulings have expanded the definition of what constitutes real-estate property, opening up the possibility of conversion to more companies. “Each time there’s a new ruling that expands the scope and clarifies the government’s position on these issues, it expands the opportunities for other…companies to pursue conversion,” he said.

Source: Wall Street Journal