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Shopping Centers Today -> July 2001
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REACTION TO REIT RULING MIXED
By Dave Bodamer
Reaction to the Internal Revenue Service’s ruling that would allow companies to spin off their real estate assets as a REIT has so far been mixed among industry professionals.
Early last month, the Internal Revenue Service revoked the 1973 interpretation of the original legislation that barred REITs from “actively” managing portfolios. The ruling changes the definition of a REIT from a passive investment vehicle to a company that is allowed to actively manage its portfolio the same as any other property-owning entity.
The ruling potentially opens the door for companies that own real estate to spin those divisions off as REITs.
Some Wall Street analysts have suggested that companies such as McDonald’s or Wal-Mart Stores, which command large real estate portfolios, may spin those divisions off as REITs. However, other analysts have said that the income from real estate is too great a factor in those companies’ revenue streams for them to consider such a move. Instead, they say, the new interpretation could lead to existing REITs potentially splitting operations into multiple REITs.
In 1973 the IRS defined REITS as “passive” investment vehicles, meaning that they could not manage portfolios with respect to rental activity that produces income. That definition was not changed even after a 1986 law allowed REITs to actively manage their portfolios. The 1986 law helped spark the modern wave of shopping center developers becoming REITs.
In practice, the 1986 law relaxed the original legislation and gave leeway to REITs to manage portfolios, but the law still defined them as passive entities. The new ruling specifies that companies and REIT spin-offs must both be engaged in active businesses. The upside of companies spinning off real estate divisions into REITs is that those assets and the income would become tax-exempt. Mitchell J. Speiser, a restaurants analyst at New York City-based Lehman Bros. estimated that McDonald’s could unlock $270 million in value by forming a spin-off.
While a REIT must pay out 90% of its profits as dividends to stockholders, Speiser estimated other benefits would more than offset the dividend payments. Overall rental income for McDonald’s is $856.7 million, which would be moved from the parent company’s overall revenue of more than $14 billion to the REIT spin-off. However, other analysts said the requirement to pay dividends would discourage companies from forming REIT spin-offs. In fact, Wal-Mart has already said that it has evaluated the strategy but has no plans to take advantage of the ruling.
“We don’t think it’s meaningful to a lot of companies being discussed in media such as McDonald’s or Wal-Mart,” said David Fick, a REIT analyst from Legg Mason Wood Walker, Baltimore. “Most have real estate as a major contributor to cash flow. If the companies form REITs, they have to pay dividends and that takes away capital those companies need.” “We see other opportunities,” Fick said. “Instead of a troubled REIT liquidating itself, it could split into two or more companies to separate its stronger properties or divisions from its weaker ones. That was not possible under the old guidelines.”
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