REITs are designed for companies that primarily invest in and generate revenue from real estate holdings, such as hotel chains; like other publicly-held corporations they trade on the stock market. There are special tax advantages for REITs, which generally pay no income tax. They also must distribute at least 90 percent of their income to shareholders in the form of dividends.
Although CCA and GEO operate prisons as their primary form of business, the prisons themselves constitute real estate. By creating an entity called a taxable REIT subsidiary (TRS), the companies can separate the operational side of their private prison management from the real estate side of owning and generating income from correctional facilities.
There are various rules and regulations governing REITs; for example, at least 95 percent of a REIT’s income “must be derived from ‘passive’ financial investments ... as opposed to ‘active’ income from business activities,” and “at least 75 percent of a REIT’s income must be derived from real estate sources...” according to the IRS. Further, a REIT cannot have over 25 percent of its assets invested in non-qualifying securities or stock of taxable REIT subsidiaries.
On January 1, 2013, GEO Group announced that as of the end of 2012 it had “completed all the necessary restructuring steps” to convert to a REIT. This included divesting itself of its GEO Care subsidiary, which provided medical and mental health services through government contracts, including at some prisons and jails. REITs are restricted in the direct or indirect operation of health care facilities.
“Our Board and our management team strongly believe that these important steps will maximize our company’s ability to create shareholder value given the nature of our assets, help lower our cost of capital, draw a larger base of potential shareholders, provide greater flexibility to pursue growth opportunities, and create a more efficient operating structure,” GEO’s chairman and CEO, George C. Zoley, said in a press release. GEO created a TRS to handle its non-real estate related operations, including “managed-only contracts, international operations, electronic monitoring services, and other non-residential facilities.” This arrangement “will allow GEO to maintain the strategic alignment of almost all of its diversified business segments under one entity,” the company stated.
GEO Group authorized an initial special dividend of $350 million, amounting to $5.68 per share of common stock payable to shareholders of record as of December 10, 2012.
CCA made a similar REIT-related announcement on January 2, 2013, stating that it had “completed an internal reorganization of its business operations so that it now has the ability to elect to qualify as a real estate investment trust (REIT) for the taxable year commencing January 1, 2013.”
CCA is expected to make an initial estimated dividend distribution of $700 to $750 million to shareholders once it converts to a REIT, which it described as “a complex process.” In a May 2012 press release, the company said the benefits of the conversion would include “an increase in long-term shareholder value, a more tax-efficient corporate structure with higher cash flow, and a lower cost of capital, while maintaining access to ample capital to fund future growth.”
In fact CCA had converted to a REIT previously, in 1997, with disastrous results. CCA formed Prison Realty Trust and a separate operating company, but due to various factors, including poor management decisions, the REIT defaulted on its debt and the company’s stock dropped to under $1.00 a share, putting it at risk of being delisted from the New York Stock Exchange. CCA subsequently reversed its REIT conversion, and faced shareholder lawsuits that alleged various corporate officers and directors had concealed information and made false and misleading statements. The suits were eventually settled for approximately $104 million in stock and cash. [See: PLN, July 2000, p. 1.]
However, the rules applicable to REITs have changed since CCA’s initial unsuccessful venture into REIT territory, including the enactment of a federal law, the REIT Modernization Act, which went into effect in 2001. REITs no longer have to have a completely separate company to manage their non-real estate business operations, but can now own 100% of a TRS. And while REITs must distribute at least 90 percent of their income in the form of dividends, the dividends do not have to be paid entirely in cash but can be distributed as a combination of cash and stock.
While both CCA and GEO have positioned themselves for conversion to REIT structures, neither company has received approval from the IRS despite their requests for a private letter ruling (PLR) regarding their REIT intentions. The companies are unlikely to finalize their REIT conversions until they receive a PLR, which will create a binding under-standing between the IRS and the requester with respect to the tax issue that is the subject of the ruling. There is no time frame in which the IRS must issue a PLR.
Regardless, the prospect of CCA and GEO Group converting to REITs has piqued the interest of investors, and both companies’ stock prices have increased as a result. In early January 2013, CCA’s stock hit a 13-year high, trading at up to $37.25 per share, while GEO traded as high as $32.24 per share in December 2012 after announcing its $350 million special dividend distribution.
Previously, on November 20, 2012, PLN managing editor Alex Friedmann, who owns a small amount of CCA stock – and who previously served time in a CCA-operated facility – filed a shareholder resolution that would require the company to disclose certain information regarding its REIT conversion. The resolution asks CCA to issue a report addressing 1) disadvantages to stockholders, and/or advantages to the company, should it make required REIT dividend distributions primarily in the form of stock rather than cash; 2) the extent to which CCA’s Board has taken into account the outcome of the company’s prior conversion to a REIT and the shareholder lawsuits that resulted; and 3) how CCA plans to comply with IRS rules governing REITs, including the limitation on REIT assets that can be held in TRSs.
As this issue of PLN goes to press, CCA has not indicated whether it will file an objection to the resolution with the Securities and Exchange Commission (SEC), as the company did in response to a shareholder resolution filed by Friedmann in 2011 that asked CCA to report on its efforts to reduce prisoner rape and sexual assaults in its for-profit facilities.
That resolution failed to pass, although it received almost 20 percent of the voting shares. [See: PLN, June 2012, p.32; March 2012, p.18].
Sources: Nashville Post, Nashville Business Journal, Nashville Scene, press releases from CCA (January 2, 2013) and GEO Group (January 1, 2013), www.irs.gov, Investor’s Business Daily, www.truth-out.org, www.reit.com
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