Long-term, negative side of REITs argued
Not everyone associated with the casino industry has caught REIT fever.
Several analysts and insiders aren’t sold on the notion that real estate investment trusts — where casinos are spun-off into a separate publicly traded company and leased by back to an operator — as being a good move for all gaming companies.
The short-term gains — tax benefits, a boost in stock prices and potentially lower debt — can be overshadowed by long-term issues. Often times, the interests of the operating company collide with the interests of property owners.
“Right now, they are a way for shareholders to make a quick buck and solve some quick problems,” said Jason Ader, the co-head of activist hedge fund SpringOwl Asset Management. “Long term, there are some negative issues for the properties themselves.”
Alex Bumazhny, director of gaming, lodging and leisure research for Fitch Ratings Service, said lowering debt burdens is preferable before organizing a REIT spinoff. Investors in the REIT want to see financially healthy tenants, which, in most cases, is the remaining operating company.
The 2013 spinoff of Gaming and Leisure Properties by Penn National Gaming, where the casino operator pared 21 of its 29 casinos and racetracks into a publicly traded REIT, is viewed as a success story. The properties are leased back to Penn through a management contract.
Bumazhny said gaming companies currently exploring REITs are “looking past their capital structure limitations” because of the PENN-GLPI model.
NOT THINKING THROUGH THE PROCESS?
The gaming industry has embraced REITs, which, by law, don’t pay federal income taxes. With real estate as their primary source of income, REITs are required to distribute at least 90 percent of their taxable earnings to shareholders.
In addition to Penn National, four other gaming companies — Pinnacle Entertainment, Boyd Gaming Corp., MGM Resorts International, and Caesars Entertainment Corp. — have either either made the decision to move into a REIT, are exploring the idea, or have had the concept presented to them.
Pinnacle is the closest to a transaction, announcing in November it was moving forward with the split. Caesars Entertainment is seeking permission from a federal bankruptcy judge for convert its largest operating division into a REIT as part of a pre-packaged Chapter 11 restructuring.
Boyd Gaming said it has spent $3 million exploring the REIT idea while an activist investor in MGM Resorts suggested a the company create a REIT as way of boosting the stock price and lowering debt.
Ader, a former Wall Street analyst who is an independent member of the Las Vegas Sands Corp. board, said some gaming companies are not thinking through the process.
Hotel-casinos — especially Strip resorts where occupancy averages in the 80 percent to 90 percent range — have high capital expenditure needs for room upgrades, restaurant changes and other areas to improve the product.
The conflict, Ader said, comes when its time to pay for the upgrades.
“I think REITs make a lot of sense for shopping malls, but casinos are in an industry that requires a high amount of maintenance,” Ader said. “Once they are split off, then the two companies have different objectives.”
Las Vegas Sands was approached about sending its Strip casinos and Pennsylvania resort into a REIT in 2012 by hedge fund Land and Buildings Investment Management, the same investor behind the MGM offer. The idea dissolved when Las Vegas Sands stock price increased.
Moody’s Investor Service gaming analyst Keith Foley cautioned that REITs might sound like a great solution for high debt, but there can be challenges.
“The operating companies have a lease,” Foley said. “If they default on the lease payment, there is a problem.”
LOWERING DEBT LEVELS
The lodging industry has more than a dozen hotel REITs of varying size, including Ryman Hospitality, Ashford Hospitality Trust, Host Hotels and Resorts, and Summit Hotel Properties.
In a research note this month, Deutsche Bank lodging analyst Chris Woronka said hotel REITs have under-performed this year because of visitation softness in various markets. However, REITs are continuing to acquire hotels in busier tourist locations — San Francisco, Los Angeles and South Florida.
“It’s no coincidence that these are also the markets that have been reporting the strongest year-over-year revenue per available room growth,” Woronka said.
Ader said REITs can “work in the hotel industry, but they are not perfect.”
Gaming analysts support REITs also long as corporate debt can be reduced.
Caesars is looking to eliminate $10 billion of Caesars Entertainment Operating Co.’s $18.4 billion debt through the REIT conversion. The casinos would be leased for $635 million a year by an operating parent company.
Bumazhny said the “Caesars case is somewhat unique since the company is in bankruptcy and can cut debt as part of the process.”
Foley said the sale and leaseback model of a REIT may be the only way highly leveraged casino operators can lower their debt levels.
“Many casino operators are highly leveraged in an environment where industry fundamentals will remain weak,” Foley said. “If interest rates go up, the combination of higher financing costs and weak fundamentals could make refinancing much more of a challenge for stressed operators than in the past.”
The problem he sees with some companies is they have to retire old debt by raising new debt through the REIT process.
Pinnacle said it would need to raise up to a $1 billion for the REIT process. This month, GLPI offered to pay Pinnacle $4.1 billion for the company’s 15 regional casinos. The REIT would then lease the casinos back to Pinnacle for $358 million a year in rent.
Foley expressed support for the offer because it would save Pinnacle from selling $700 million in stock.
A QUESTION OF TIMING
National hotel and restaurant workers union UNITE HERE filed a proxy with the Securities and Exchange Commission on Thursday, telling shareholders there were “significant risks” with the Pinnacle REIT proposal.
GLPI is the gaming industry’s only REIT and the union pointing out the volatility of hospitality REITs. UNITE HERE also questioned the timing of the planned REIT conversion.
“Interest rates have remained at a historic low, but it is not known when the cost of borrowing may be raised,” the union wrote in its filing. “The impact of higher future interest rates could have a negative impact on real estate values.”
Another issue for GLPI is diversification. The company has bought just one other casino, a riverboat property in Illinois, since the split with Penn National. A deal for a race track casino near Pittsburgh fell apart.
Analysts said GLPI may start exploring real estate outside of gaming in order to widen its portfolio.
Contact reporter Howard Stutz at hstutz@reviewjournal.com or 702-477-3871. Find him on Twitter: @howardstutz.
