Don't Bet On a Casino REIT

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Penn National Gaming (NASDAQ: PENN) shares shot up after it announced plans to split itself into a gaming company and a real estate investment trust (REIT). This follows on the heels of a number of other companies announcing or making similar shifts. While it makes sense for some companies, it is probably best for investors to avoid Penn National's “casino REIT” when, and if, it comes along.

Penn National
Penn National owns and operates gaming and horse racing facilities in Colorado, Florida, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Maryland, Mississippi, Missouri, Nevada, New Jersey, New Mexico, Ohio, Pennsylvania, Texas, West Virginia, and Ontario. Its focus is on slot machines, owning over 36,000 of them, though it also has over 800 game tables and nearly 3,000 hotel rooms.

There is no doubt that the company's physical properties have material value. In fact, many are in areas where building new casinos would be virtually impossible because of space constraints or legal and regulatory issues. It is interesting that the company would seek to unlock the value of its property by spinning them off to shareholders in a REIT. Penn will remain the casino operator, but not the casino owner. This is the first casino operator to consider such a spin off, so it is likely to face particular scrutiny from regulators. That said, investors sure seemed to like the announcement.

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PENN data by YCharts

Not The First Company To Do This
Although Penn is the first casino to make or announce such a business shift, it is hardly the first company to make use of the REIT structure in this way. For example, Gaylord Entertainment recently became Ryman Hospitality Properties (NYSE: RHP). Essentially, Ryman lets Marriott International handle the day to day operations of its group-oriented resort hotels, while it just sits back and collects the rent. After struggling for years trying to turn its conference center business around, time will tell if the move to a REIT makes sense.

Other companies in the process of, or that have already made, a similar REIT shift include Lamar (NASDAQ: LAMR), Iron Mountain (NYSE: IRM), and American Tower (NYSE: AMT). Lamar is in the billboard advertising space, Iron Mountain owns document storage facilities, and American Tower owns cell towers. All interesting shifts that seem to make sense.

An Industry Shift?
Not too long ago, REIT conversions “swept” though the paper industry. Companies with massive land holdings which provided the primary input (trees) for their paper operations realized that converting to or spinning off lumber REITs would be a good way to enhance shareholder value. Companies making this change included Potlach, Rayonier, and Weyerhaeuser. They all joined Plum Creek as lumber REITs. One could easily understand a similar move in the billboard, document storage, and cell tower industries, as companies look to enhance shareholder value and avoid the double taxation of dividends.

The big difference between a timber REIT (and the other REITs noted above) and a casino REIT, however, is growth potential. And this is why you should avoid the first casino REIT. Indeed, there is plenty of timber land (billboards, document storage facilities, and cell towers) available, but casino properties are harder to come by. Moreover, as noted above, casinos can be very difficult to build because of the stigma and legal issues surrounding these properties. Thus, a casino REIT will likely have a hard time expanding its portfolio. If a slow to no-growth REIT is what you are looking for, then maybe a casino REIT is the answer for you. But I doubt it.

A Bigger Concern For The REIT Industry
My concern with the Penn REIT idea isn't for its shareholders, however; it is for the entire REIT structure. With tax issues taking center stage, more and more scrutiny has been placed on so-called tax loopholes. For example, there is a great deal of concern about the carried interest loophole and how shutting that one loophole might impact financially focused limited partnerships (LP). That said, the concern has actually engulfed the entire LP industry.

Limited partnerships are pass-through entities that have a tax advantaged corporate structure. REITs are such entities, and if there is a perception that the REIT structure is being abused, the entire industry could wind up loosing its tax advantage and get taxed at the corporate level. Lumber REITs make sense, billboard REITs make sense, cell tower REITs make sense. Casino REITs are a much harder sell and could actually result in the other conversions being re-examined with a more critical eye, giving additional ammunition to those who might seek to close a perceived tax loop hole.

I think investors should avoid the casino REIT and hope Penn's move doesn't damage an important industry for investors seeking to gain access to investment properties.


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ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool owns shares of American Tower and Weyerhaeuser Company. Motley Fool newsletter services recommend American Tower . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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