By Eric Hawthorn
It’s gone from an obscure industry term to the sort of investment buzzword whose use extends far beyond the worlds of real estate and Wall Street, entering the parlance of everyday media outlets and the lay public.
There’s a good reason for this: the corporate structure has seen a tremendous boost in popularity during the last couple of real estate cycles: the early aughts CRE bubble brought more and more investment capital to REITs across asset types up until the market downturn, and then the REIT concept saw a second wind as investors saw an opportunity for stability and yield during the incredibly bearish years of 2009-2011 or so. The tax-advantaged, carefully regulated nature of REITs is certainly attractive to stakeholders, and to investors/developers/operators, since the REIT structure has proven a fundraising juggernaut for the capital-intensive commercial real estate space.
As the REIT concept has emerged into the mainstream (thanks to recognition by S&P and major media), two major trends have taken hold: REIT formations (via restructuring from standard c-corp status, or via M&A activity) and REIT spin-offs.
Today I want to talk about REIT spin-offs, which have become a major part of companies’ growth/liquidity/market-expansion strategies in a variety of ways. We saw Simon Property Group exercise a major REIT spin-off a few years ago in an effort to separate its top-tier assets like the King of Prussia Mall and high-sales-per-SF outlet centers from its non-core holdings, and that move has proven worthwhile for both SPG and its spin-off. We’ve seen major quasi-real-estate firms in the fields of solar, telecom, data storage, and even billboard advertising (!) embark on the process of REIT conversion (with the eventual support of the IRS, who loosened its REIT criteria to allow for a wider breadth of asset types), and in many cases these companies report success through these measures.
On the other hand, we’ve also seen REIT spin-off attempts work as sort of last-ditch liquidity grabs for non-real estate players like Darden Restaurants, Sears Holdings, and up until recently, McDonald’s. And as spin-offs become more and more diverse, the real estate industry seems to be learning that the strategy is not a panacea for flagging corporations–though it certainly can be profitable if exercised carefully.
A recent Commercial Property Executive piece written by Fitch Ratings’ REIT analyst Steven Marks points out,
With the recent increase in companies converting to REIT status, expect some bad with the good.
The trend of companies converting to REIT status, or “REIT-ization,” has been around since 2010, but it’s picked up steam in recent months.
REITs have generally formed out of traditional corporate industrial companies in two ways: the conversion of a C corporation to REIT status or the spin-out of a C corporation’s operating real estate into a separately traded REIT, often referred to as an “OpCo/PropCo” spin-off.
On the surface, REIT-ization seems like a sure thing: eliminating many corporate taxes, attracting investment through attractive dividends… And for companies like McDonald’s and Darden, to focus on examples from the restaurant space, it’s often viewed as a great way to unlock shareholder value through large real estate portfolios.
A while back we saw Darden sell its massive Red Lobster restaurant brand to Golden Gate Capital, with former Nicholas Schorsch triple-net empire ARCP (which, post Schorsch and post scandal, has rebranded itself as VEREIT) taking over the real estate portfolio through a sale-leaseback deal. That move proved controversial at the time, with Darden shareholder and activist muckrakers Starboard Value using that deal as a pretext for unseating Darden’s leadership. Starboard may have been right: VEREIT has since realized handsome profits with its recent sale of the Red Lobster restaurant portfolio, suggesting the assets were undervalued when Darden parted with them.
On the other hand, Sears Holding’s Seritage REIT, a collection of spun off properties from the sinking Titanic that is Sears, has been sharply criticized for helping to gut Sears’ real estate holdings and displace its value into a different entity (so: Seritage may be a winning premise, but its existence arguably hurts its mothership).
And finally we have McDonald’s. Much to the chagrin of REIT spin-off proponent Larry Robbins (a hedge fund boss), the company’s recently touted plan of separating some of its corporately held restaurant properties into a REIT has been axed.
McDonald’s leadership cites concerns that the move would diminish the value of the company’s brand and potentially harm its ongoing efforts to grow its franchise base. While the jury’s out on whether or not this is true (probably we’ll never know), it’s clear that Ronald McDonald is part of a very small minority that has not jumped on the REIT bandwagon.
Maybe the fast food titan is on to something. A company is more than its real estate, after all. We shouldn’t forget that.