February 11, 2008
All about REITs | Concerned about timberland development, a Penobscot County legislator targets real estate investment trusts
By Whit Richardson
In December, Rep. Robert Duchesne (D-Hudson) introduced a bill in Maine's Legislature that, if passed, could significantly impact the state's largest property owners, from the Chicago-based owner of the Maine Mall to the Seattle company that owns huge swaths of Maine's forestland.
The bill challenges the tax status of real estate investment trusts, or REITs, which avoid corporate income tax as long as they pay out at least 90% of their taxable income to shareholders in the form of dividends. From Duchesne's perspective, REITs have found ways to reap huge profits tax-free from real estate development that weren't intended when Congress created REITs in 1960. In Maine, according to Duchesne, that means being forced to sit and watch as revenue from the development of Maine land flows across the border without benefitting the state.
His response to those worries is LD 2074, An Act To Reestablish Fairness in Corporate Taxation by Taxing Real Estate Investment Trusts, which would tax REITs at the corporate level on capital gains, such as the sale of land or property, something current law does not allow.
While there are several different types of REITs, Duchesne, a member of the Legislature's natural resources committee, primarily is concerned with timberland REITs. Duchesne suspects that timberland REITs, which are a relatively new phenomenon in the timberland business, are under more pressure to pursue development than traditional timberland owners. And with the ownership of Maine's timberlands changing hands at a rapid pace, Duchesne is worried that an acceleration of REIT ownership in Maine could lead to problems in the future.
Over the past decade, paper and lumber companies have shed millions of acres of Maine timberland to focus on their core business of making paper or processing lumber. Between 1998 and 2007, roughly 7.5 million acres of Maine timberland changed hands, according to data from the James W. Sewall Co. in Old Town. Some of that land has been bought by timberland investment management organizations, which act as brokers for investors looking to diversify their investment portfolio with timberlands. But one of the big players in this relatively new crop of Maine timberland owners is Plum Creek Timber Co., a REIT that has snapped up roughly 928,000 acres in Maine.
Plum Creek is the only timberland REIT currently operating in Maine, but the Seattle-based company owns 4.4% of the state, which ties Maine with Georgia for being the most REIT-owned state in the country, according to data compiled by Duchesne. And among Duchesne's chief concerns is that more REITs will come into Maine and follow the lead of Plum Creek, which has spent more than three years developing a high-profile, large-scale development plan for 20,000 acres in northern Maine.
For some, REIT ownership of Maine's timberlands isn't a big deal. They note that REITs manage their land the same as any other timberland management company, and that their usual focus on long-term ownership could actually benefit Maine. But others, including Duchesne, believe the emergence of timberland REITs raises troubling questions that need to be answered.
Among those questions is whether REIT holdings in Maine will increase. Duchesne believes that other major timberland REITs, such as Jacksonville, Fla.-based Rayonier Inc. and Spokane, Wash.-based Potlatch Corp., which have been buying land in other timber-rich states, could be attracted to Maine if more and more timberland goes on the market. "My suspicion is as timberland management companies are converting to REIT structure we'll see more REIT purchases in the state of Maine," Duchesne says. "I thought it was time to have this conversation before we travel too far down this REIT road."
Duchesne doesn't believe he can stop this trend, but he believes the state should start the conversation about how to deal with timberland REITs, and how Maine can benefit from them.
The Legislature's taxation committee held a public hearing on the bill on Feb. 5, as this issue of Mainebiz went to press. Duchesne expects to be an unpopular figure at the hearing, as lobbyists and pro-business advocates are lined up to fight the bill.
Under Duchesne's own admission, the bill probably won't emerge from the taxation committee this session. Still, he calls it a conversation starter. "I think of this as a green apple. It's not ripe yet, but one day it will be."
The end of the road
Traditionally, REITs have focused on commercial properties like shopping malls or hospitals, but the timberland REIT is a relatively new phenomenon. Plum Creek was the first publicly traded timberland management company to convert to REIT status, which it did in 1999. Since then, other major publicly traded timberland management companies have made the switch, including Rayonier and Potlatch Corp.
Meanwhile, Weyerhaeuser, one of the world's largest publicly traded timberland management companies, is seriously considering becoming a REIT, according to Brooks Mendell, owner of Forisk Consulting, a Georgia-based forest industry research firm. "In terms of publicly traded [timberland companies] there aren't many candidates left," Mendell says. "We're down to the end of the road here. Weyerhaeuser is the last major prize on the table."
But transitioning to a REIT also poses challenges, Duchesne says. Because a REIT is required to keep 75% of its assets as real estate, and because it is required to distribute most of its profits, it is very limited in how much cash it can keep in order to purchase new lands or expand the company, Duchesne says. But since 2001, with the passing of the federal REIT Modernization Act, REITs like Plum Creek can circumvent that problem by owning non-REIT subsidiaries to handle real estate development, allowing the company to develop land, keep the cash and use it to grow the company. "My concern is that REITs following this business model don't engage in huge Moosehead Lake-style development because they want to," Duchesne writes in an email. "They do it because they have to."
But whether a REIT manages its timberland differently than a traditional company is up for debate. David Field, professor emeritus of forest resources at the University of Maine in Orono, believes the idea that REITs are more likely to develop their timberland than traditional timberland management companies is "absolutely foolish." He says timberland REITs are under the same pressures as other timberland owners. "There is of course pressure to return as much as possible to its owners, but that's true whether it's a REIT or a corporation or anybody else," Field says. What's more, the vast majority of the lands owned by a REIT like Plum Creek are "remote, more or less ordinary timberland," he says. "It's not valuable waterfront property."
As for Plum Creek, the company argues the bill would put the company at a competitive disadvantage, and that it already pays its dues in the form of property taxes and the wages it pays out. In 2007, Plum Creek paid Maine $2.3 million in taxes, says Kathy Budinick, a company spokesperson. The company also supports 78 forest products companies and 60 small business contractors that employ a combined 5,500 people in Maine, she says. "If this legislation passed, Plum Creek would no longer be operating on a level playing field," Budinick says.
Besides, Budinick says, Duchesne's argument doesn't hold water because Plum Creek created a subsidiary to do its real estate development work, and that subsidiary is taxed by the state.
Duchesne points out two problems with that argument. One, Plum Creek bought the land from Sappi in 1998 for $200 an acre, but would sell those acres deemed appropriate for development to its taxable subsidiary for fair market value, which would skyrocket if it were waterfront land zoned for development. That revenue is not taxed under the current tax structure. But it would under his bill, Duchesne says. His second argument: that this bill is not meant to target Plum Creek. Any other REIT could come into Maine and try to develop real estate without using taxable subsidiaries, he says.
The issue is fairness in taxation, Duchesne says. REITs distribute their income to shareholders in the form of dividends, which are then taxed by the states where those shareholders live. So, in theory, if none of those shareholders live in Maine, the state would not see any revenue from the sale and development of thousands of acres of timberland in Maine. "There will be a lot of state income collected in New York, Connecticut, Massachusetts, on income generated in Maine that will be not touched by Maine," Duchesne says. "One of the tenets of taxation is income is taxed where it's generated, but with REITs it's not. Sooner or later, someone's going to ask why."
Collateral damage
Under Duchesne's bill, REITs would not be taxed on revenue generated from rents and leases, but only on capital gains, such as the sale of property or hard assets. The bill would allow the state to trace the income generated from capital gains in Maine back to the corporation, and tax that income on the corporate level. To avoid the concerns for double taxation, the bill would allow Maine shareholders in a REIT that operates in Maine to subtract any income from their dividends that had already been taxed as income by the state on the corporate level, according to Dennis Doiron, the director of the income/estate tax division at Maine Revenue Services. Revenue generated from the tax would be dedicated to the Land for Maine's Future Fund.
Duchesne says his bill is not targeted at the 20 other non-timberland REITs that currently operate in Maine, but he admits it could certainly impact those operations if they ever sell property. Some of Maine's most high-profile commercial properties are owned by REITs, such as the Maine Mall, the Bangor Mall, the 65 outlet stores that make up Kittery Premium Outlets along Route One, and Sugarloaf and Sunday River, which were purchased last year by CNL Income Properties, a Florida-based REIT.
Non-timberland REITs say the bill could be a slippery slope. Once a state starts taxing REITs on capital gains, it could start taxing other things, like income generated from collecting rents and leases. It's an argument Duchesne admits is valid, but one that can't be helped. "Whenever people take a fresh look at taxation policy, you start asking yourself some hard questions and sooner or later somebody will go there," he says. "So I can see where they could be worried, but that's not my intention."
Maine is not the first state to try taxing REITs on the corporate level. Ron Kuykendall, a spokesman for the Washington, D.C.-based National Association of Real Estate Investment Trusts, says other states over the years have considered the idea, but have always backed off because the move would put a state "out of sync with every state of the union." "I think there would be backlash," he adds. "You're seeing a lot of wealth being generated and funneled into the economy in Maine. If you create an environment in which these companies are disadvantaged doing business there, they're not going to want to be there."
Duchesne cribbed language for his bill from one introduced in Montana's Legislature last year. That bill proposed taxing REITs on the corporate level on everything, not just capital gains. It was defeated last year, but Duchesne says another version of the bill has been introduced this year, and that it has the support of Montana's governor and the head of that state's revenue department. "I think this will be a growing trend once states wake up to this," he says.
It's happened before. For a while, companies like Wal-Mart were using a tax loophole in the way some states taxed REITs to basically pay rent to itself, avoiding paying millions in taxes. States eventually got wise to the loophole and closed it. Duchesne says the same will happen in this situation.
But for now he just wants to begin the conversation, and doesn't mind being the sacrificial lamb who takes the brunt of criticism. "I expect to take a pounding on it, but it's the kind of conversation we have to have, but are always afraid to have," he says. "I'll know this apple is ripe when other people are taking credit for it ˆ whenever people say this was their idea years from now."
The bill challenges the tax status of real estate investment trusts, or REITs, which avoid corporate income tax as long as they pay out at least 90% of their taxable income to shareholders in the form of dividends. From Duchesne's perspective, REITs have found ways to reap huge profits tax-free from real estate development that weren't intended when Congress created REITs in 1960. In Maine, according to Duchesne, that means being forced to sit and watch as revenue from the development of Maine land flows across the border without benefitting the state.
His response to those worries is LD 2074, An Act To Reestablish Fairness in Corporate Taxation by Taxing Real Estate Investment Trusts, which would tax REITs at the corporate level on capital gains, such as the sale of land or property, something current law does not allow.
While there are several different types of REITs, Duchesne, a member of the Legislature's natural resources committee, primarily is concerned with timberland REITs. Duchesne suspects that timberland REITs, which are a relatively new phenomenon in the timberland business, are under more pressure to pursue development than traditional timberland owners. And with the ownership of Maine's timberlands changing hands at a rapid pace, Duchesne is worried that an acceleration of REIT ownership in Maine could lead to problems in the future.
Over the past decade, paper and lumber companies have shed millions of acres of Maine timberland to focus on their core business of making paper or processing lumber. Between 1998 and 2007, roughly 7.5 million acres of Maine timberland changed hands, according to data from the James W. Sewall Co. in Old Town. Some of that land has been bought by timberland investment management organizations, which act as brokers for investors looking to diversify their investment portfolio with timberlands. But one of the big players in this relatively new crop of Maine timberland owners is Plum Creek Timber Co., a REIT that has snapped up roughly 928,000 acres in Maine.
Plum Creek is the only timberland REIT currently operating in Maine, but the Seattle-based company owns 4.4% of the state, which ties Maine with Georgia for being the most REIT-owned state in the country, according to data compiled by Duchesne. And among Duchesne's chief concerns is that more REITs will come into Maine and follow the lead of Plum Creek, which has spent more than three years developing a high-profile, large-scale development plan for 20,000 acres in northern Maine.
For some, REIT ownership of Maine's timberlands isn't a big deal. They note that REITs manage their land the same as any other timberland management company, and that their usual focus on long-term ownership could actually benefit Maine. But others, including Duchesne, believe the emergence of timberland REITs raises troubling questions that need to be answered.
Among those questions is whether REIT holdings in Maine will increase. Duchesne believes that other major timberland REITs, such as Jacksonville, Fla.-based Rayonier Inc. and Spokane, Wash.-based Potlatch Corp., which have been buying land in other timber-rich states, could be attracted to Maine if more and more timberland goes on the market. "My suspicion is as timberland management companies are converting to REIT structure we'll see more REIT purchases in the state of Maine," Duchesne says. "I thought it was time to have this conversation before we travel too far down this REIT road."
Duchesne doesn't believe he can stop this trend, but he believes the state should start the conversation about how to deal with timberland REITs, and how Maine can benefit from them.
The Legislature's taxation committee held a public hearing on the bill on Feb. 5, as this issue of Mainebiz went to press. Duchesne expects to be an unpopular figure at the hearing, as lobbyists and pro-business advocates are lined up to fight the bill.
Under Duchesne's own admission, the bill probably won't emerge from the taxation committee this session. Still, he calls it a conversation starter. "I think of this as a green apple. It's not ripe yet, but one day it will be."
The end of the road
Traditionally, REITs have focused on commercial properties like shopping malls or hospitals, but the timberland REIT is a relatively new phenomenon. Plum Creek was the first publicly traded timberland management company to convert to REIT status, which it did in 1999. Since then, other major publicly traded timberland management companies have made the switch, including Rayonier and Potlatch Corp.
Meanwhile, Weyerhaeuser, one of the world's largest publicly traded timberland management companies, is seriously considering becoming a REIT, according to Brooks Mendell, owner of Forisk Consulting, a Georgia-based forest industry research firm. "In terms of publicly traded [timberland companies] there aren't many candidates left," Mendell says. "We're down to the end of the road here. Weyerhaeuser is the last major prize on the table."
But transitioning to a REIT also poses challenges, Duchesne says. Because a REIT is required to keep 75% of its assets as real estate, and because it is required to distribute most of its profits, it is very limited in how much cash it can keep in order to purchase new lands or expand the company, Duchesne says. But since 2001, with the passing of the federal REIT Modernization Act, REITs like Plum Creek can circumvent that problem by owning non-REIT subsidiaries to handle real estate development, allowing the company to develop land, keep the cash and use it to grow the company. "My concern is that REITs following this business model don't engage in huge Moosehead Lake-style development because they want to," Duchesne writes in an email. "They do it because they have to."
But whether a REIT manages its timberland differently than a traditional company is up for debate. David Field, professor emeritus of forest resources at the University of Maine in Orono, believes the idea that REITs are more likely to develop their timberland than traditional timberland management companies is "absolutely foolish." He says timberland REITs are under the same pressures as other timberland owners. "There is of course pressure to return as much as possible to its owners, but that's true whether it's a REIT or a corporation or anybody else," Field says. What's more, the vast majority of the lands owned by a REIT like Plum Creek are "remote, more or less ordinary timberland," he says. "It's not valuable waterfront property."
As for Plum Creek, the company argues the bill would put the company at a competitive disadvantage, and that it already pays its dues in the form of property taxes and the wages it pays out. In 2007, Plum Creek paid Maine $2.3 million in taxes, says Kathy Budinick, a company spokesperson. The company also supports 78 forest products companies and 60 small business contractors that employ a combined 5,500 people in Maine, she says. "If this legislation passed, Plum Creek would no longer be operating on a level playing field," Budinick says.
Besides, Budinick says, Duchesne's argument doesn't hold water because Plum Creek created a subsidiary to do its real estate development work, and that subsidiary is taxed by the state.
Duchesne points out two problems with that argument. One, Plum Creek bought the land from Sappi in 1998 for $200 an acre, but would sell those acres deemed appropriate for development to its taxable subsidiary for fair market value, which would skyrocket if it were waterfront land zoned for development. That revenue is not taxed under the current tax structure. But it would under his bill, Duchesne says. His second argument: that this bill is not meant to target Plum Creek. Any other REIT could come into Maine and try to develop real estate without using taxable subsidiaries, he says.
The issue is fairness in taxation, Duchesne says. REITs distribute their income to shareholders in the form of dividends, which are then taxed by the states where those shareholders live. So, in theory, if none of those shareholders live in Maine, the state would not see any revenue from the sale and development of thousands of acres of timberland in Maine. "There will be a lot of state income collected in New York, Connecticut, Massachusetts, on income generated in Maine that will be not touched by Maine," Duchesne says. "One of the tenets of taxation is income is taxed where it's generated, but with REITs it's not. Sooner or later, someone's going to ask why."
Collateral damage
Under Duchesne's bill, REITs would not be taxed on revenue generated from rents and leases, but only on capital gains, such as the sale of property or hard assets. The bill would allow the state to trace the income generated from capital gains in Maine back to the corporation, and tax that income on the corporate level. To avoid the concerns for double taxation, the bill would allow Maine shareholders in a REIT that operates in Maine to subtract any income from their dividends that had already been taxed as income by the state on the corporate level, according to Dennis Doiron, the director of the income/estate tax division at Maine Revenue Services. Revenue generated from the tax would be dedicated to the Land for Maine's Future Fund.
Duchesne says his bill is not targeted at the 20 other non-timberland REITs that currently operate in Maine, but he admits it could certainly impact those operations if they ever sell property. Some of Maine's most high-profile commercial properties are owned by REITs, such as the Maine Mall, the Bangor Mall, the 65 outlet stores that make up Kittery Premium Outlets along Route One, and Sugarloaf and Sunday River, which were purchased last year by CNL Income Properties, a Florida-based REIT.
Non-timberland REITs say the bill could be a slippery slope. Once a state starts taxing REITs on capital gains, it could start taxing other things, like income generated from collecting rents and leases. It's an argument Duchesne admits is valid, but one that can't be helped. "Whenever people take a fresh look at taxation policy, you start asking yourself some hard questions and sooner or later somebody will go there," he says. "So I can see where they could be worried, but that's not my intention."
Maine is not the first state to try taxing REITs on the corporate level. Ron Kuykendall, a spokesman for the Washington, D.C.-based National Association of Real Estate Investment Trusts, says other states over the years have considered the idea, but have always backed off because the move would put a state "out of sync with every state of the union." "I think there would be backlash," he adds. "You're seeing a lot of wealth being generated and funneled into the economy in Maine. If you create an environment in which these companies are disadvantaged doing business there, they're not going to want to be there."
Duchesne cribbed language for his bill from one introduced in Montana's Legislature last year. That bill proposed taxing REITs on the corporate level on everything, not just capital gains. It was defeated last year, but Duchesne says another version of the bill has been introduced this year, and that it has the support of Montana's governor and the head of that state's revenue department. "I think this will be a growing trend once states wake up to this," he says.
It's happened before. For a while, companies like Wal-Mart were using a tax loophole in the way some states taxed REITs to basically pay rent to itself, avoiding paying millions in taxes. States eventually got wise to the loophole and closed it. Duchesne says the same will happen in this situation.
But for now he just wants to begin the conversation, and doesn't mind being the sacrificial lamb who takes the brunt of criticism. "I expect to take a pounding on it, but it's the kind of conversation we have to have, but are always afraid to have," he says. "I'll know this apple is ripe when other people are taking credit for it ˆ whenever people say this was their idea years from now."
Most Recent
Most Recent
Comments