To the Telecommunications Assets with Alacrity

Investors are increasingly looking into innovative investment opportunities, such as securitizing telecommunications assets. This week while discussions about plummeting oil prices and potential interest rate increases were driving the discourse on the direction of the markets, Goldman Sachs stated that it would invest $470 million in a REIT that invests in cell towers. These telecommunications assets are becoming more and more important, as data-dependency is increasing, and investors are capitalizing on this growing demand for data.

The space is currently controlled by three substantial companies, as well as many minor participants. However, perceived potential for returns is driving investors to consider deploying significant capital into the space; this trend would theoretically result in an increase in the number of players and perhaps minimize the market share of the predominant participants.

As the amount of data demanded is rising rapidly, the current rate of consumption will result in IP traffic exceeding the 1000 Exabyte threshold, the equivalent of the memory of more than 10^20 iPhones, by 2016. Moreover, the data demanded by mobile users will account for more than fifty-percent of the total traffic by the same year. In 2018, the gross global internet traffic will be 64 times the volume of gross global internet traffic in 2005. Investors are aware of these trends, and they are reacting accordingly.

The increase in data demand will have a remarkable effect on investors in real estate. In August, the IRS announced that it would allow certain companies investing in telecommunications assets to possibly qualify for REIT status. Although these announcements do not ensure that the space will expand in the future – past announcement are not used as precedent for future decisions – they indicate an inclination to enable an expansion in the definition of real estate.

American Investors are Adapting to Reduced Returns

Today, the confluence of the economic environment in Europe and the uncertainty about China is causing foreign investors to acquire assets in the US and compelling American investors to adapt. The slowdown in China’s GDP growth and the stagnation in Europe are leading investors to look for secure and stable investments. Consequently, they are increasingly looking to invest in the United States, resulting in rising real estate prices in cities like New York and San Francisco. Investors are as a result seeking returns in secondary markets.

Investors from across the globe are bidding up prices in the US as they look for places to put their money. They are less likely to acquire assets in Europe, as its economies are experiencing sluggish GDP growth. There are signs that the Eurozone may be on the verge of recession.  Investors understand that there are structural issues with the Eurozone economies. They are loath to invest in the area given its economic environment, as well as Eastern Europe’s social instability. Investors are instead looking to acquire assets in the US. 

Additionally, the apprehension about the course of the Chinese economy is convincing investors to transfer their wealth to the US. There is speculation that the Chinese economy will not experience the rapid rates of GDP growth that it experienced in the 1990s and 2000s. Public policy, as well as other issues, may prevent its economy from expanding as it becomes less dependent on exports.  As a result, investors are acquiring assets in the US, in particular New York and San Francisco.

These investors are interested in acquiring assets that they perceive to be secure and stable. The assets of choice have been prize properties, such as the Waldorf Astoria that was acquired for a record amount this month.  Investors from East Asia, the Middle East, and Scandinavia are investing in these prized properties in city centers in cities like Boston and New York. As a result, the values of offices in these areas have risen to 10% over the previous price peak in 2007.

U.S. investors are consequently investing in assets in other markets with the potential for greater returns. U.S. investors are finding that they getting a better bang for their buck in cities that are considered secondary to cities, such as New York and Boston. Additionally, investors have been investing their capital increasingly in developments and redevelopments. 

Going forward, investors should consider the pressure on real property prices caused by the influx of foreign capital, and the impact that it’s having on returns. The intelligent investor will seek out returns in markets outside of those considered to be the homes of prized properties, as well as in development and redevelopment projects.

Changes to the REIT Space

In 2014, the Internal Revenue Service (IRS) issued Written Determinations that, in effect, enabled certain companies to be considered REITs. The IRS affirmed in these instances elections to consider certain assets as real property; this could have broad ramifications for certain sectors.

There are implications for strategies related to asset acquisitions for REITs, as the rulings by the IRS may result in there being additional asset classes – such as, IT infrastructure, agriculture, and advertising – that may prove to be attractive, high-yielding investments. Moreover, the IRS rulings indicate that the definition of REIT might be more malleable than previously thought, which implies that there could be more opportunities to profit from the expansion of the REIT space.

The Written Determination of the IRS impact the potential for firms to save on taxes, thereby affecting their ability to compete. The IRS ruled in the determinations mentioned above, as well as determinations not released to the public, in favor of certain companies electing to be treated as REITs. Certain companies may then benefit from their status as REITs through decreases in taxes. Previously, the IRS did not indicate that it would be willing to treat certain companies as REITs. Although the IRS is clear that these rulings may not be viewed as precedent and only apply to the companies that are the subject of the rulings, certain companies with businesses similar to the companies addressed directly by the IRS may look to the rulings as indication that the assets or asset types discussed in the rulings can be securitized.

If the IRS rulings are truly indicative of willingness to treat certain companies that securitize the assets or asset types discussed in the rulings as REITs, there may be more REIT spin-offs to come in the near future. In 2014, plans have already been released for major REIT spin-offs that have the potential to change the REIT space. In August, Windstream LLC announced that it would establish Windstream REIT through securitizing its IT assets. Windstream received a ruling from the IRS indicating that the IRS was willing to treat the assets owned by Windstream REIT as real property. The assets owned by Windstream REIT include IT infrastructure that previously had not been considered real property. Similarly, Iron Mountain Inc. announced that it would convert to Iron Mountain REIT after the IRS indicated that its assets would be treated as real property.

The IRS rulings and the subsequent decisions to spin-off assets into REITs can cause significant consequences, both positive and negative, to the tax-base and to certain companies that may elect to have their assets treated as real property. Although the rulings can potentially erode the tax base – which may lead to renewed focus on attempts by corporations to avoid paying their share of taxes – certain companies can save on taxes and gain access to cheaper capital. REIT conversions or spin-offs with their benefits may enable certain companies to succeed. There is speculation that the REIT spin-off announced by Windstream may cause larger players in the telecommunications space to consider similar restructuring.