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Iron Mountain Incorporated (IRM), Rayonier Inc. (RYN): IRS Rethinking REIT Conversions Is Good News

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Iron Mountain Incorporated (NYSE:IRM) saw its shares drop over 15% in one day because the Internal Revenue Service is raising questions about its planned conversion to a real estate investment trust (REIT). Although that may sting the company’s shares, and a few others, it’s a good thing for the REIT industry.

Iron Mountain Incorporated (NYSE:IRM)

Everyone in the water

Wall Street does most things in grand style. That’s what leads to the excesses that result in bubbles and the unfortunate aftermath when a bubble inevitably bursts. The wave of REIT conversions that has been gaining steam has the potential to quickly reach such excess. That, in turn, could forever tarnish a valuable income producing asset class.

The wave started with paper companies. PotlachRayonier Inc. (NYSE:RYN), and Weyerhaeuser Company (NYSE:WY) all converted to lumber REITs at around the same time. The transition made logical sense, since the companies generate revenue from their land holdings. That said, there are important differences to note between owning an apartment and owning timberland.

Rayonier Inc. (NYSE:RYN), for example, has an important business in the cellulose area of the paper market and plans to keep pressing growth in the niche. Cellulose, however, is an end product that has little to do with owning timberland. You only get cellulose from processing timber. Sure, it’s a great business that held up well while the housing market was weak, but it is a far cry from the occupancy, rent concession, and improvement cost issues that traditional REITs deal with.

Avoiding taxes

The benefit of shifting from a paper company to a timber REIT was in the avoidance of corporate level taxes. That’s good for shareholders and the company, but should raise eyebrows at the IRS. Since such conversions seemed to be getting an easy pass, Wall Street started to go into overdrive with REIT conversions.

Corrections Corp Of America (NYSE:CXW), for example, believes it will save $70 million in taxes after converting to a REIT. Although Corrections Corp Of America (NYSE:CXW) owns prisons, it doesn’t just rent them out, it gets paid to run them. From the company’s annual report: “We are compensated for operating and managing facilities at an inmate per diem rate based upon actual or minimum guaranteed occupancy levels.” In other words the company gets paid based on the number of inmates in its facilities. One treads a fine line when deciding if that’s a service or a space rental.
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