Real estate was a dirty word after the bubble burst in 2008-2009. The belief being that rampant real estate speculation was to blame. Real estate was shunned for a few years, but has started to catch hold again.
Driven by – none other than – low-interest rates. REITs have been a great place to invest. But another part of real estate that’s getting hot is the new spinoffs of real estate from established retailers and restaurant chains.
This trend has been growing with the activists looking to score a victory by spinning off the real estate into a REIT and original shareholders receive REIT shares in proportion. The REIT shares can be then sold and a form of dividend or buyback benefit is passed onto the investors without spending a single dollar. And to top it off, the transaction is usually structured to be tax-free.
Gates Capital Management's Excess Cash Flow (ECF) Value Funds have returned 14.5% net over the past 25 years, and in 2021, the fund manager continued to outperform. Due to an "absence of large mistakes" during the year, coupled with an "attractive environment for corporate events," the group's flagship ECF Value Fund, L.P returned 32.7% last Read More
Tax-free – that’s helped catch the attention of the IRS, which is debating whether the transactions fulfil the spirit and form of the law. The IRS recently released a notice indicating that it, along with the U.S. Treasury Department, is concerned that corporations are using spinoffs of assets to avoid paying taxes on otherwise taxable transactions.
The IRS has stopped ruling on any requests regarding such spin offs while it examines the issues. Activists have been pushing spinoffs as selling real estate to a REIT or others would involve a capital gains tax, whereas if the real estate spin off is coupled with a qualifying business asset, they are tax free. The qualifying business asset cannot include collecting rent and this has led to creative solutions by companies.
Darden Restaurants (NYSE: DRI), for example, is the operator of more than 1,500 casual dining restaurants under the brand names of Olive Garden, LongHorn Steakhouse, Bahama Breeze etc. chose to spin off a 6 unit LongHorn operation in San Antonio as part of its real estate spinoff. This was orchestrated by the activist fund Starboard Value, which was successful in removing the entire board of Darden in a proxy war. In this case, the qualifying assets would have been too small to generate interest from the IRS.
Demand for real estate spin offs have also been made at Macy’s (NYSE: M), McDonald’s (NYSE: MCD) and MGM (NYSE: MGM). Land and Buildings, a Connecticut based activist fund specializes in REIT transactions, has been targeting MGM.
While activist investors are clamouring to pick a fight, doing so with the IRS is another story? We shall see.