Real estate investment trusts (REITs) can serve more industries than just real estate. When you hear the term “REIT” most people think of traditional REITs, such as office, industrial, residential, or retail properties.
Today, non-traditional REITs are gaining popularity in industries outside of real estate. You might be wondering how a REIT gets around various testing and the rules of being restricted to owning real estate. Here are a few other industries that can benefit from forming a REIT and how.
The marijuana industry is on the rise as New Jersey recently became 1 of 19 states (including D.C.) to legalize recreational marijuana in addition to dozens of states that have medical use laws. A cannabis REIT can serve as a funding source providing much needed capital through a leaseback transaction. The marijuana company would sell its real estate to a REIT, then lease back the property at an arms-length rate. This gives the company an influx of cash for its operations, in addition to passing off some operational burdens of owning a building. Companies can also enter into a loan with the REIT to buy or build out their real estate, similar to mortgage REITs. The REIT makes money on the loan interest and the company has another way to finance its building, a plus considering the challenges marijuana companies face trying to secure a lease with various zoning and legal restrictions.
What’s considered arms-length? The recommendation is to have a transfer pricing study done.
Hotel and Lodging REITs
A previous Withum article covered impermissible tenant service income so you might be wondering how a hotel REIT gets around those rules. REITs must derive their income from rents, not from operating a secondary business. Strictly speaking, operating a hotel would not qualify as permissible income for a REIT. In a hospitality REIT, the REIT simply owns the building and land, rents the property to a taxable REIT subsidiary (TRS) who then contracts with a third-party independent contractor (IK) to run the hotel operations. When leasing to a TRS, the lease needs to be an arms-length transaction. The lease can be structured to receive a fixed base rent plus a percentage of gross revenue. Note that percentage of net revenue is not allowed for a REIT as that is construed as being involved in the operations of a company.
Hospitals, medical offices, medical research facilities, and senior care facilities fall into this category. Like hotel REITs, healthcare REITs are prohibited from directly operating a facility. Instead, the REIT leases the property to a TRS (through an arms-length transaction), which contracts with a third-party independent contractor (IK) to operate the healthcare facility on behalf of the TRS. The IK must be in the business of managing unrelated healthcare properties. It is important to note that both lodging and healthcare facilities cannot be run by a TRS directly.
These could include self-storage, cold storage, or document storage. Cold storage REITs own temperature-controlled warehouses and are crucial players in the food industry. Storage REITs cannot engage in certain activities such as record handling, scanning or faxing records, courier services, and secure document shredding. They would need to engage an outside party for those activities.
Cell Tower, Data Center, and Infrastructure REITs
According to Forbes, besides the major cell phone providers there are three big players in 5G technology, and they are all REITs. Between cell towers, data centers, small cell towers, and other infrastructure such as fiber networks, it takes a lot of real estate to transmit information. These REITs hold the real estate assets and lease the use of the assets to technology companies. REITs can design the system, oversee construction, monitor the systems, and perform inspections and minor repairs without causing issues.
Data center REITs own and manage real estate that customers use to safely store data. These REITs can provide telecommunications infrastructure and certain “remote hands” services directly without any issues of impermissible income. According to an article by S&P Global Market Intelligence from December 2020, communication and data center REITs recently raised $15.46 billion and $9.75 billion in capital, respectively (Mooney & Hudgins, 2020).
Just had to throw this one in here to grab your attention. Yes, prison REITs are a real thing! Prison REITs own detention facilities that they lease back to government agencies. It’s worth noting here that there have been legislative proposals that would limit or eliminate federal use of private prisons.
Wrap Up and Next Steps
In every scenario the REIT owns, operates, and manages the real estate assets, and leases the property to another party who operates the business. A REIT helps with raising capital while the operating company can focus on its business without the added burden of being a landlord.
Author: Ashley Kettler, CPA, Real Estate Services Team Member
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