Feature: Two Giants Decide Against REIT Structure

Will the decision by Macy's and McDonald's to say "no" to the REIT structure make other execs think twice?

Two big-name companies, Macy’s Inc. and McDonald’s Corp., recently decided to say “no” to the REIT structure.

Macy’s Inc., in its latest quarterly report, announced it would not create a REIT for its stores, while McDonald’s Corp., in its latest investor meeting, announced that it would not spin off its properties into a REIT. The news by both companies was disappointing to some investors, and possibly suggests that some executives considering a REIT structure are taking a longer look than usual.

“Every retailer considering a REIT should think twice. What might be a good option for one could be a bad idea for another,” Wally Wahlfeldt, JLL’s executive vice president of national retail corporate services, told CPE. “Retailers need to evaluate on a case-by-case basis; it’s not a one-size-fits-all solution.”

Thomas Lasky, Forum Group LLC’s managing member, doesn’t believe these decisions are an indication of an anti-REIT trend.

“It’s actually bucking a pro-REIT trend recently embraced by Sears and Darden Restaurants. Both McDonald’s and Macy’s had independent reasons to decline to spin their real estate assets into a REIT,” Lasky told CPE. “It’s likely that these companies intend to send a message to the public and prospective investors that the corporation is well positioned and possesses sufficient liquidity, so a REIT is unnecessary. There’s clearly a desire to boost investor confidence by this move.”

In its investor meeting, McDonald’s CEO Steve Easterbrook said that company leaders determined that a REIT was not in the best interest of shareholders, with the potential upside not compelling enough and the risks too great. McDonald’s also cited execution risk related to the current political environment and recent statements made by both the Treasury Department and the IRS regarding REIT conversions.

Britton Costa, Fitch Ratings

Britton Costa, Fitch Ratings

Macy’s determined that there would not be enough value created, along with the aforementioned operational and tax considerations. Factors included the size of the REIT, how a single-tenant department store REIT would be valued and the impact on the retailer’s leverage.

“Macy’s appears to be taking a multi-faceted approach to its real estate holdings, including considering joint ventures to redevelop certain flagship assets, while pursuing selected dispositions where the value of the retail business is outweighed by the value of the real estate,” observed Gary Albrecht, co-chairman of Cole Schotz’s real estate department.

Reasons for both McDonald’s and Macy’s also included operational considerations.

“McDonald’s, for example, derives approximately a third of its revenues from its franchisees (which includes royalties, rent on both owned and leased properties, and fees),” explained Britton Costa, director in Fitch Ratings‘ U.S. REITs group. “Meanwhile, Macy’s plans to close/reposition a number of stores would be complicated should they have been subject to a master lease. Owned real estate provides more flexibility for issuers amid change such as the department store industry.”

Emery Matthews, co-founder & principal with Real Estate Interests LLC, noted that both companies’ decisions are neither anomaly nor representative of a fundamental shift.

“In fact, their decisions have little to do with REITs or the REIT structure itself. REITs remain the most tax efficient means of owning large portfolios of similarly situated assets,” he said. “Instead, the Macy’s/McDonald’s debate is much more about capital structure and finance than the appeal (or lack thereof) of REITs.”

Macy’s and McDonald’s, as well as similar retailers, control significant real estate portfolios that make attractive sell-off targets, and in many cases, Matthews added, it makes sense to try to further monetize these assets.

“There are very valid, strategic reasons why McDonald’s and Macy’s would still not want to use a REIT — and in some cases those reasons are very similar to the reasons for not wanting to mortgage real estate through a bank,” he said. “Specifically, relinquishing ownership of real estate could have a negative impact on operations, rising interest rates (or the threat thereof) could greatly diminish the value of the real estate placed in a REIT, and the operating company’s credit rating could be negatively affected, which could raise the cost of capital going forward.”

According to Lasky, the retail sector (particularly soft goods) generally had a disappointing third quarter 2015. He forecast lower fourth-quarter sales going into the holiday season, making continued significant REIT activity likely to increase corporate liquidity and provide shareholder dividends.