Fair warning to REIT enthusiasts: Things could get a little bumpy in the asset class soon.
Shares of Iron Mountain (IRM) — a provider of data backup, record management and other tech services — had plunged by 15% late Friday on word that its proposed conversion into a real estate investment trust will be reviewed by the IRS. The ruling also hampered datacenter operator Digital Realty Trust (DLR), which was down more than 3%.
REIT rules and regulations have come under scrutiny recently as companies with widely varied businesses — from prisons to datacenter operators — look to gain the tax-advantaged status.
These non-traditional REITs are providing some outsized returns for investors hungry for yield, but with more and more companies pushing the envelope to gain REIT status, the IRS is taking a longer look at those applications.
Enter Iron Mountain.
IRM filed a Form 8-K on Thursday with the Securities and Exchange Commission informing it of the company’s decision to pursue a conversion to a REIT. The IRS has formed a new internal working group to study the Iron Mountain case (and presumably others down the road) to determine whether IRM’s facilities are in fact considered “real estate” and thus qualify for REIT status.
Iron Mountain operates more 1,000 facilities spanning 64 million square feet across 35 countries. It will need to, at a minimum, convince the IRS that 75% of its operating income is derived from “rent” associated with the holdings, per IRS rules.
The mere possibility IRM might not qualify led Stifel Nicolaus to lower its rating from “buy” to “hold,” and investors took that as their exit cue this morning.
It’s unclear what the timing will be for an IRS decision, but Iron Mountain shareholders should brace themselves for a rocky waiting period where every headline could make waves. It’s also unclear whether the increased scrutiny will lead to the IRS reviewing existing REIT-approved companies; the slump in Digital Realty Trust suggests some view it as a real possibility.
Meanwhile, the IRS’ response to IRM might give pause to other companies hoping to make the same leap.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities.