There has been a fair amount of conversation in the last several weeks regarding companies choosing to convert to real estate investment trusts (REITs). Most recently, the debate has been seasoned by American Tower, an owner and operator of wireless communication data towers, identifying as a REIT. While, on the surface, this may seem like an abuse of the tax code, it is important to remember the spirit of the legislation that allowed for REITs (and their favorable pass-through taxation) in the first place.
Ownership in valuable, attractive, investment-grade real estate is typically out of the reach of most investors. REITs are vehicles in which more modest-worth investors may enjoy the benefits of this asset class. Yet, “investment-grade” real estate is not defined as “office towers” or “apartment buildings.” Rather, in a very broad sense, investment-grade real estate is any ownership interest in real property that can generate current or future income. Why is this important? While it may be obvious to most how to generate income from a piece of land in downtown Seattle (build an apartment building, rent out the apartments), it may not be obvious how to generate income from unique, small, rural, or complex interests in land. Many companies, such as American Tower or Weyerhaeuser (which converted to a REIT in 1999), may not have customers who live or work directly on their land, yet they derive the bulk of their income from the operation of real estate.
American Tower develops and owns data transmission towers, and then sells (or leases) “bandwidth” on those towers to communication companies. This complex and unique operation could not be possible without the underlying real estate. Further, it would not be feasible for a typical investor to access this particular kind of real estate revenue, so this seems consistent with the spirit of REITs. However, REITs must pay most of their income directly to shareholders (as dividends), thus limiting the amount of retained earnings available for aggressive growth. As wireless communication continues to evolve, so will the way in which land must be utilized for that purpose. Therefore, I make no assessment as to whether or not the REIT structure is the best for American Tower from a business growth perspective.
– Jonathan Kilpatrick