Income investors should take a moment to thank
President Dwight D. Eisenhower. It was Ike who signed into law the Cigar Excise Tax Extension of 1960, which included an amendment that gave small investors a chance to directly participate in the returns generated by diversified portfolios of income-producing real estate. Up until then investing in things like hotels and apartment buildings was strictly a big money institutional game.
The law mandated that
real estate investment trusts pay out no less than 90% of their income to their investors as taxable dividends.
REITs in turn got to exempt that income from corporate taxes. Today there are 129 equity REITs representing a combined market cap of more than $500 billion.
It’s been a great source of income and total return for investors for decades. Over the last ten years the Dow Jones U.S.
Real Estate Index (IYR), comprised almost exclusively of REITs, has beaten the S&P 500 return by 80%. Since the depths of the financial crisis in early 2009 REITs have returned more than 220%.
Now, 50 years after REITs’ inception, the industry is buzzing again. A generation of boomers craves income, and more and more companies have become wise to tax and other advantages of the REIT structure. Everyone wants to get in on the REIT bonanza, as operating businesses from cellphone towers to timber companies, billboard firms and private prisons are converting to REITs.
Initially the REIT approach to real estate investment, as established by Congress, contemplated land and the improvements on it. At least 75% of REIT income needed to be derived from real estate, typically in the form of rent. But lately that definition of “rent” has become as loose as getting paid to store, manage and retrieve documents, as pending REIT convert Iron Mountain argues.
Here is how Iron Mountain rationalizes its reawakening as a REIT. “The foundation of Iron Mountain’s business is renting space to enterprises for the storage of their physical records. … Storage rental is the primary driver of our revenues, profits and cash flows. As such, we operate a substantial real estate network comprising more than 64 million square feet across nearly 1,000 storage facilities.”
Since Iron Mountain announced its intention to become a realty trust in early June, its stock has appreciated 38%, quintupling the total return of the S&P 500. Assuming the
IRS approves Iron Mountain’s application, it should be a full-fledged REIT by January 2014.
Lumber company Weyerhaeuser became a REIT in 2010. Since its conversion its total return, comprising stock appreciation and dividends, has far exceeded close competitors and the market.
Recent IRS rulings, including one issued in October 2011, have potentially opened the door for billboard REITs. The rulings found that billboards and sign superstructure are real property even if the signs are just bolted to a building.
Suddenly Lamar Advertising, one of the largest outdoor advertising firms, has announced plans to pursue REIT status. Never mind any notion that Lamar’s core competency was providing advertising solutions. Real estate pays better dividends. “We believe the REIT structure would be a natural fit for us. At the core we provide real estate and real-estate-related services to advertisers,” says Chief Executive Sean Reilly.
Data center companies Equinix and Cincinnati Bell-owned
CyrusOne have also said they are exploring REIT status. They would join three existing data center REITs:
Digital Realty Trust, ?DuPont Fabros Technology and ?
CoreSite Realty, expanding this industry segment, which provides storage space for the growing Internet cloud.
Soon prison owners like
Corrections Corp. of America may go REIT, as will energy-related property owners, owners of sports venues and solar farms.
The expanding REIT industry is great news for yield-hungry investors because it gives them a chance to create a diversified portfolio of income generators from nearly every sector of the economy. In the case of solar energy, for example, REITs may actually represent a smarter way to play the sector.
Tom Konrad, editor at AltEnergyStocks.com, explains, “Currently the only way a small investor can invest in solar is by buying stock in solar manufacturers.” He argues that fierce competition makes solar manufacturers a bad investment.
Indeed, since its inception in April 2008 Guggenheim’s Solar ETF (TAN) has fallen 94%, while solar installations have grown sixfold and costs have plummeted.
Adds Konrad, “While falling costs destroy manufacturer margins, they improve the opportunities for solar farms.”
So far the IRS has not ruled on whether solar farms would qualify as REITs. That hasn’t kept California industrial REIT Prologis from entering the business. IRS rules allow REITs to generate up to 25% of their income from sources other than real property, and this would allow some solar on REIT-owned buildings.
Prologis plans to equip 10% of its 600 million square feet of industrial roof space with solar photovoltaic panels. Andrew Duffy, portfolio manager with Ascent Investment Advisors, warns against being blinded by REIT dividends. Says Duffy, “Focus on whether you like the company’s business for the long term. At the end of the day, qualifying as a REIT isn’t going to magically transform a weak business model into a strong one.”
Jens Nordvig, Nomura Securities
BUY The
Mexican peso (MXN). Mexico has weathered the economic storm well. Its GDP is expected to grow about 3.5% in 2013, with unemployment falling and consumer confidence rising. Oil, a burgeoning middle class and a recovering manufacturing sector are making it a prime destination for foreign capital.
SELL Japanese yen (
JPY). Beware this safe-haven currency trap. Forex strategist Nordvig thinks the yen short will be 2013′s big trade. While the world’s third- largest economy lingers in stagnation, consistently on the verge of deflation, its currency sees inflows. Expect Japan‘s trade deficit to balloon.
By Brad Thomas
Taken from:
http://www.forbes.com/sites/bradthomas/2012/11/26/reits-boom-as-more-industries-discover-this-tax-friendly-structure
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