Office buildings, shopping centres and apartments: This is the stuff REITs are made of.
Except, increasingly, the universe of U.S. real-estate investment trusts is populated by vehicles that own property of a slightly different kind. Cell-phone towers and data centres. Self-storage centres. Casinos, prisons and roadside billboards.
Call them, perhaps, "non-traditional" REITs. A number of U.S. companies are engaging in an exercise that should be familiar to Canadians who have watched the changes in the retail industry at home: They're trying to strip out the value of real estate from old, tired operating companies that investors have grown bored with.
The product of their efforts provides Canadians with a few more options when seeking dividend-payers south of the border.
The U.S. created REITs , in which the trust pays no corporate income tax if it passes the vast majority of its earnings on to shareholders, in 1960, says Ron Kuykendall, a spokesman for NAREIT, the national REIT trade group. He says the definition of what a REIT may hold was left broad, at land and the improvements on it, because of the expectation the economy would evolve. So the expanding number of non-traditional REITs isn't due to any sort of policy change by the U.S. Internal Revenue Service, he says, but because companies wanting to take advantage of investors' postrecession interest in income have approached the IRS for a "private letter ruling" that allows them to convert into a REIT.
Let's meet some of them.
One of the recent pioneers in REIT conversions is American Tower Corp., once a sexy growth story built on ever-increasing demands for cell-phone service. (I recommended it in the pages of the Globe in March 2011, at about $50 (U.S.) It closed Friday at .)
American Tower converted to REIT status at the beginning of 2012. Competitor Crown Castle International Corp. followed at the beginning of this year. (Another competitor, SBA Communications, reports an adjusted earnings figure each quarter as if it were a REIT, suggesting either a desire to convert, or for an apples-to-apples comparison.)
But while Crown Castle is following the income playbook – its dividend yield currently sits at 4.1 per cent – someone forgot to tell American Tower it's no longer a growth stock. Its forward price-to-earnings ratio is close to 40, its dividend yield is a paltry 1.4 per cent and it increased its revenue by nearly 30 per cent, year-over-year, in the third quarter through acquisitions and organic growth.
And Wall Street loves it, with 20 of the 24 analysts providing coverage rating it a "buy," with an average target price of $110.
"American Tower, with its scale, conservative financial position, and focus on profitability, has been the most stable tower company and offers an attractive risk/reward at this level," says J.P. Morgan analyst Philip Cusick, who has an "outperform" rating and $121 target price.
Iron Mountain Inc., a document storage and services company, performed one of the more dramatic REIT conversions earlier this year when it obtained an IRS ruling in June that the steel racks holding its customers' boxes qualified as real estate. Since the company is electing to make the conversion retroactive to January 1, it needs to pay "catch-up" dividends in December – a total of 73 cents for shareholders who buy in by Nov. 28 and hold through Dec. 5.
Analyst Kevin McVeigh of Macquarie Securities says these payments underscore a "durable model," and the company trades at a sharp discount to the average industrial REIT. He doesn't see the company's multiple catching up in the next 12 months, however, and has a $40 target price (versus Friday's close of ) to go with his "outperform" rating.
Publicly traded Penn National Gaming Inc. spun off its real estate into Gaming and Leisure Properties Inc. in 2013. Right now, it's the only gambling game in REIT town, says analyst Cameron McKnight of Wells Fargo Securities, although two other companies, Pinnacle Entertainment Inc. and Boyd Gaming Corp., have said publicly that they're considering doing the same.
Mr. McKnight, who has an "outperform" rating for the stock, says it is cheaper than other "triple-net-lease" REITs (where the REIT's tenants take on the expenses of property taxes, insurance and maintenance), yet is likely to grow its dividend more quickly than those peers, even though it's an already-healthy 6.5 per cent. (The shares are down 36.5 per cent this year, making it the only negative performer of the nontraditional REITs we looked at.)
CBS Corp. spun off its billboard operation as CBS Outdoor Americas Inc. in March and got the IRS's blessing to convert a few weeks later. Lamar Advertising Co. became a REIT Wednesday after getting shareholder approval. In both cases, advertising income from outdoor billboards was deemed rent on real property – but analysts like Jason Bazinet of Citigroup Global Markets say outdoor REITs deserve the low end of the group's multiples "because they are ad-based and cyclical, own very little real estate and do not have market capitalizations that are large enough to be included in the REIT indices." His "buy" rating on CBS Outdoor is premised largely on what he expects to be a 6.9-per-cent dividend yield, up from about 5.4 per cent today.
Uncomfortable with profiting from incarceration? Skip Corrections Corp. of America and The GEO Group Inc., whose real estate is private prisons and whose rent is the money governments pay to keep criminals locked up. Corrections Corp. actually converted to a REIT once before, abandoned the structure and re-adopted it in 2013.
The small number of analysts who follow the two companies are more positive than analysts for other non-traditional REITs. All six analysts following GEO have a "buy" rating, including Tobey Sommer of SunTrust Robinson Humphrey, who says "prospects for a substantial acceleration in growth [are] modest," but the dividend yields are attractive and risks to growth are "subdued."
Attractive dividend yields. Growth risks subdued. Maybe many of these non-traditional REITs will fit in just fine with their old-style peers.