Are data centers real estate? That question is being examined by the Internal Revenue Service (IRS) as it reviews its guidelines for real estate investment trusts (REITs). The agency has formed an internal working group to define its standards for REIT status, and will not approve any new applications for REIT status until the process is completed.
That news hit the stock prices of Equinix (EQIX) and Iron Mountain (IRM), which have both applied to convert to REIT status. Shares of Equinix fell more than 5 percent on Friday after the company disclosed the IRS review, but bounced back 2 percent in early trading Monday. Iron Mountain shares slumped 16 percent Friday.
The review follows a New York Times story last month that raised questions about data center operators seeking conversion to REIT status, characterizing it as a tax avoidance strategy that "creates the image of a loophole." It also raised questions about the inclusion of leased property in a REIT.
Precedent for Data Center REITs
A REIT is a corporation or trust that uses the pooled capital of many investors to purchase and manage income property. Income comes from the rent and leasing of the properties, and REITs are legally required to distribute 90 percent of their taxable income to investors. Four of the largest data center developers – Digital Realty (DLR), DuPont Fabros (DFT), CoreSite Realty (COR) and CyrusOne (CONE) – are organized as REITs.
Equinix believes there is a clear precedent for data center developers as REITs.
"Equinix cannot predict when the IRS working group will complete its study or what the outcome of the study will be," the company said in a statement. "However, Equinix continues to believe, based on both existing legal precedent and the fact that other data center companies currently operate as REITs, that its data center assets constitute real estate for REIT purposes."
QTS (Quality Technology Services) declined comment on whether it was considering a REIT conversion, but said it was an appropriate business structure for data centers.
“As a privately-held company, QTS maintains the right not to divulge financial information," said a QTS spokesperson. "However, data centers at their core are real estate enterprises and are well within the framework of REIT rules.”
The executive team at Iron Mountain seems confident that the delay won't the company's share price for very long. President and CEO William Meaney bought 12,000 shares of the stock after its decline, while several directors also were buyers of the company's shares.
Are data center development companies appropriate to operate as REITs? Share your opinions and insights in our comments.