More REIT Conversions: Billboards

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

There have been a rash of companies converting all or part of their businesses to real estate investment trusts (REITs) in recent years. Some have made sense, others haven't. CBS's (NYSE: CBS) recent announcement that it is looking to turn its billboard business into a REIT is one that makes sense. But how should investors look at a billboard REIT?

REIT Conversions
REITs are a great asset class because they allow for the avoidance of corporate level taxes. While shareholders have to pay taxes on the income received at their normal tax rate, it avoids the onerous double taxation that regular dividends suffer. So, in the long run, a company that makes sense as a REIT is probably doing shareholders a favor by converting to one.

The first big REIT wave of recent years took place around paper companies. 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 (PCH), Rayonier (RYN), and Weyerhaeuser (WY). They all joined Plum Creek (PCL) as lumber REITs. Generally speaking, they have been well received.

Some companies, however, don't make much sense as REITs. Take Penn National Gaming's (NASDAQ: PENN) plans to split itself into a gaming company and a REIT. Penn National owns and operates gaming and horse racing facilities with over 36,000 slot machines, 800 game tables, and nearly 3,000 hotel rooms.

Clearly, the company's physical properties have material value. More so because many are in areas where building new casinos would be virtually impossible because of space constraints or legal and regulatory issues. Penn will remain the casino operator, but not the casino owner. However, how does a casino REIT grow if it's hard or impossible to keep build casinos? Worse, does this conversion look too much like a way to avoid taxes and raise the ire of regulators?

Billboards Make Sense
Like the lumber REITs, billboard REITs make logical sense. Revenues are directly tied to the leasing of property and there are no notable negatives associated with billboards, except for the eyesore factor. So CBS looking to convert its billboards, which include such things as bus shelter signs and other similar signage, to a REIT should be a well-received move. As with most of the announced REIT conversions, CBS' stock jumped on the news. Time will tell if the market's positive view of virtually all such conversions makes sense.

CBS' decision follows Lamar's (NASDAQ: LAMR) move to the exact same thing with its billboards. With more than 140,000 billboards, Lamar will create a REIT that begins life with notable scale. However, it won't have the scale of CBS' billboard business, which tallies more than 400,000 U.S. billboards. Each, however, will be notable competitors in a fragmented industry.

Lamar's REIT will likely come to market before CBS'. The latter's announcement stated that 2014 will likely be the earliest it can convert its billboards to a REIT. The market reception of Lamar's REIT will be interesting to watch, since CBS is likely to see a similar market response.

How to Think About A Billboard REIT
Unlike casinos, the billboard industry is largely fragmented. True, there are at least a half dozen major participants, but after the large companies, there are hundreds of smaller players owning as little as one billboard. Leases can be month to month or for much longer periods, with one-year leases a common period for better situated properties. In some ways this is similar in nature to the apartment area. The fragmentation, however, provides room for acquisition based growth, which is a long-term positive.

Unlike apartments, however, results in the billboard REIT space will be heavily impacted by economic cycles. Indeed, with a mixture of national advertising and local advertising, a weak economy could be a particular drag on results. Big advertisers might pull back from second tier locations, while local adverting could dry up altogether. Thus, investors need to keep a keen eye on economic activity.

Regional exposure could also be an issue, though Lamar and CBS both have broad exposure. That said, if certain areas of the United States were to be suffering more than others, billboard occupancy and lease rates in those areas could come under pressure. This is one to watch if smaller, less geographically diversified billboard REITs come to market.

Costs should be manageable and relatively steady. In many cases, a billboard space is leased by the billboard company for long periods and resold to advertisers for shorter periods. Upkeep is usually fairly negligible, since there isn't nearly much to maintain on a billboard as there is on a property that is used or occupied in some way. The billboard company's lease costs should be watched, to ensure that increases don't outstrip the company's ability to raise lease rates with its customers.

A notable negative, however, is that lease rates are based on supply and demand, and on competing advertising channels. While billboards in high demand areas will likely have stable to increasing lease rates (think Times Square in New York City), less desirable locations will probably see rates fluctuate a lot more. This could make the top line, and dividends, more variable than other property types. It could also lead these companies to maintain dividend levels at the lowest possible legal level (90% of earnings). 

Billboard REITs Worth a Look
At the end of the day, Lamar and CBS are probably making a good decision by converting their billboards to REITs. Although neither will consummate these plans soon, investors should keep an eye on their progression. This could be the start of a new industry going through a REIT conversion wave.


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ReubenGBrewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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