Here’s a clue for Jeopardy fans: It started with cigar taxes, evolved from a casino never built, was re-energized by a bankruptcy, and includes a magnificent fountain and a hidden golf course.
You can just hear James Holzhauer or Ken Jennings buzzing in with “What’s a Gaming REIT?”
After reading a few dozen of Howard Stutz’ recent CDC Gaming Reports stories about yet another sale of a major casino to a REIT, you may have been wondering exactly what the hell a gaming REIT really is. If your property gets sold to a REIT, does that mean you can buy more slot machines? Will there be bigger bonuses? Who’s going to be fired, if anyone? Is there a new boss? And who’s going to patch the roof if it leaks?
Unless you’re the CFO, you may have trouble with these answers. This stuff is not about the gaming business, but rather the business of investing in the business of gaming. Most of the financial publications use confusing terms like opco and propco, which decode to Operating Company and Property Company. Just consider this sentence from a recent Jefferies publication meant to enlighten investors on Gaming REITs: “Our conclusions are that when the assets are sold solely for the reduction of traditional debt, there is progressive value degradation the more real estate is sold, according to our EV/EBITDAR and DCF estimates.”
Clearly, most of us should have paid a lot more attention in Accounting 101. Or taken it in the first place.
With apologizes to pros in the investment world, here’s a grade-school primer on Gaming REITs:
The first step is to unscramble the acronym and examine the history. The letters stand for Real Estate Investment Trust – unless you’re the Blackstone Group, which proclaims that their I stands for Income. REITs were created with the noble purpose of allowing average folk to get involved with major real estate developments by investing, either privately or publicly, through stock offerings. They were also an excellent way to raise large amounts of money.
In typically convoluted Washington D.C. fashion, the creation of REITs was part of the Cigar Excise Tax Extension of 1960. While they had absolutely no connection to stogies, REITs did generate the capital that led to a boom in both major land development and huge construction projects in the 1960s and ‘70s.
Like many investment schemes, early REITs contained a lucrative tax dodge which allowed participants to shelter earnings from other sources. That giant incentive expired with the tax reform acts of 1976 and 1986.
Today, there are still tax benefits with REITs, but without that baked-in sheltering provision, interest cooled considerably.
Giant shopping center developers, like Taubman, sparked another boom in the early 1990s with UPREITs, in which the REIT itself became part owner of a new operating group. Like it did with many things, however, the recession of 2007/08 significantly dampened REITs momentum for a while. But they’re back now, and stronger than ever. For the five-year period ending in December of 2017, all categories of REITs had compounded annual returns of nearly 10%. That’s not as good as the S&P 500, which yielded nearly 16% annually, but REITs were more stable and relatively risk-free.
Owning real estate is generally not very liquid, meaning it can be time-consuming and costly to buy and sell. However, most REITs are highly liquid, since they are publicly traded like stocks. And, because of their unique structure, REITs do not pay normal corporate taxes, which we’ll touch on in more depth later. Today, REITs are common for office and apartment buildings, warehouses, hospitals, timberlands, hotels and, lately, casinos.
In November of 2013, 53 years after its founding, Penn National Gaming established a REIT called Gaming and Leisure Properties, Inc. GLPI first explored financing a new billion-dollar casino project in Milford, MA. However, before the deal could be finalized, voters rejected the plan, and it was never built. GLPI’s REIT bought their first property in January 2014: the Casino Queen in East St. Louis, IL.
Since gaming – at least in Nevada – has been legal since 1931, what took so long? There were several obstacles, including the unique nature of casinos. Gambling used to be considered risky, and its association with organized crime didn’t help. That’s partially why it wasn’t until 1971 that Wall Street finally opened its wallet to casino investment with the first stock offering from the late William Harrah.
Secondly, and most critically, gaming is highly regulated and limited jurisdictionally. While casinos may seem like they’re everywhere, getting a new license is still difficult and getting more expensive every year. Casinos are also far from shabby today; properties that were once built for hundreds of thousands of dollars can now take millions or billions to be competitive.
Green Street Advisors, a REIT consulting group based in Newport Beach, CA, says, “Gaming is a capital-intensive industry, and the emergence of the REITs provides an attractive alternative source of capital for operators. The REITs also provide investors with a way to invest in the gaming sector, but with a far lower risk profile than offered by investments in operators.”
All gaming stocks seem fairly robust these days but it’s worth a look at the ups and down of even a strong corporation like Las Vegas Sands (LVS) for the last five years:
It would’ve been great to invest in this stock at 38 at the start of 2016 (or maybe buy a bunch like Sheldon Adelson did when it dropped to a low of 1.77 in March of 2009.) The story wouldn’t be so good if you invested at 80.47 in May of 2018, and woe betide you if you went all in at 130 in late 2007.
There are seldom such big swings with a REIT. Once an REIT buys a casino, they simply collect rents or lease payments for the property and buildings. Contractually, these payments seldom go down, but they do have escalator provisions to increase in value and can go even higher with maintenance capital improvements, which are also mandated by the deals. In other words, while the return on investments in REITs is relatively modest, they are stable, consistent and carry far less downside risk.
The creation of VICI, another large gaming REIT, was somewhat complicated. The original Harrah’s underwent many changes and acquisitions, going from Holiday Inns, to Promus, to Harrah’s Entertainment, and ultimately Caesars Entertainment. Their operating company, CEOC, eventually went bankrupt early in 2015, carrying more than $18B in debt.
As part of their Chapter 11 settlement, Caesars spun off the CEOC subsidiary, which housed a large portion of its properties, into the VICI REIT and an operating company that traded as CEOC. The VICI name came from Caesar’s Veni, vidi, vici: I came; I saw; I conquered. The creditors certainly seemed to conquer the bankruptcy court. There are few winners in any bankruptcy; in this case, the creditors got VICI. Today, in the first quarter of 2020, VICI is trading at an all-time high. In a recent take over, Eldorado Resorts (ERI) is acquiring CEOC. The resulting entity will be known as Caesars and traded as CZR when the deal finalizes early this year. (And yes, there are too many acronyms in both gaming and on Wall Street.)
The plan helped CEOC creditors by taking advantage of the tax treatment for REITs. These trusts are required to distribute 90% or more of their taxable income to the shareholders as dividends. Therefore, the REIT itself is nearly tax free. Per Wikipedia, several members of Congress opposed the bankruptcy plan, calling it an abuse of the REIT laws, and asked the IRS to deny VICI tax-free status. They were unsuccessful.
Like other REITs, VICI quickly started buying up casinos. As of this writing, they own 20 casinos and racetracks and four golf courses, including the magnificent, relatively hidden Cascata course outside of Las Vegas. The most recent VICI acquisitions were the Thistledown Racino in Cleveland and the Cincinnati Casino, both JACK Entertainment operations. In the three years since its formation, VICI has announced sale transactions of $7.6 billion.
MGM’s REIT, MGM Growth Properties LLC (MGP), was formed in the fall of 2015 as a consolidated subsidiary of MGM. All its deals have so far been with their tenant/majority owner MGM. They made big news in January of 2018 with a proposal to buy VICI for $5.9 billion, an offer VICI rejected, electing to go public instead. That didn’t slow MGP. Today, they have purchased 11 casinos in eight jurisdictions and are currently working on one of the largest sales ever. Their namesake MGM Grand Las Vegas and the strip’s Mandalay Bay are expected to be purchased sometime in Q1 of 2020. With a $4.6B price tag, MGP will be partnering with another REIT master, the Blackstone Group’s BREIT. Should the deal go through, MGP will own 50.1% with BREIT at 49.9%.
Blackstone is no stranger to the market; their total REIT investments are north of $157 billion in all sorts of industries. They made headlines recently by purchasing both the Bellagio for $4.2B, which included the famous fountains, and the Cosmopolitan for $1.73B. The new Grand/Mandalay purchase will generate annual rents of $292 million for the two partners. REIT rent payments require that the tenant pay all the operating expenses, the insurance and the property taxes and are thus known as triple-net or NNN leases.
An important question is what do the operators do with all that money from the sale? They could buy more slot machines. Or patch the roof. They probably will do many things like that, since most REIT agreements mandate a certain percentage of capital maintenance improvements to assure the property continues to increase in value. For bigger players like MGM, other objectives like reducing debt and having cash-on-hand to take advantage of any future deals (perhaps bidding for a new casino in Japan) are also strong possibilities.
Will you get fired, get a bonus and/or have a new boss? REITs should not be a factor in these decisions, particularly if you’re doing well now. In most cases, REIT transactions should have little impact on day-to-day casino operations. One of the strengths of a gaming REIT versus those for hotels or warehouses, is that casinos are pretty stable. Since licenses are restricted, it’s rare that a casino completely closes; it may change hands, but it likely won’t shut its doors.
So how to explain the recent news that the legendary Harrah’s Reno has been sold off by VICI and Eldorado Resorts to a non-gaming company? Harrah’s Reno was William Harrah’s first property, and it is now done as a casino. Hundreds of casino workers will be out of jobs, or at least forced to relocate, before the end of the year. REIT proponents explain that a single closing would have little impact on their performance, since they generally have a large portfolio of properties, and that diversity is another plus in a REIT strategy.
The operator, Eldorado Resorts (ERI), will certainly benefit from eliminating a weak competitor. They own three other strong properties in the Reno market and will be able to consolidate management and increase profitability. While it may sound like a REIT issue, this move was made as part of Eldorado’s acquisition of Caesars, which is still in progress. ERI announced that they’d trim $500 million in operational costs as part of the deal. This move, and others like it in select markets, attempts to skirt monopoly issues, in which individual operators have too many casinos in a single area. In other words, the Reno move had more to do with mergers and acquisitions strategies than with REITs.
Will every casino soon be owned by a REIT? Probably not. A little less than half of the US operators are Native Americans, and tribal operators have little use for REITs (in fact, it will probably never happen given the unique status of reservation land.) While Penn National has indicated they’ll aim for 100% REIT ownership of their casinos, other operators like Eldorado think a 50/50 balance of Opco and Propco is ideal. This may or may not be a better strategy in the event of an economic downturn. Time will tell.
Why is all of this happening now? That answer isn’t simple, either, but the most common explanation is that REITs can “unlock the value of casino real estate.” Using a hypothetical example based on some recent transactions, a standard casino operator may trade at a ratio of six to eight times EBITDA. With a REIT, the real estate portion of the company can jump to 12 times, if not more. That makes it easier to raise capital and offers those REIT investors less volatility and therefore more reassurance.
One analyst called it great financial engineering. A jaundiced layman might label it just another example of old fashioned paper-shuffling.
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Authors Note: – If you’re contemplating the choice of investing in a casino operator or a REIT, the answer probably sounds a lot like your 401k administrator’s sales pitch. If you seek higher returns and are willing to take on some risk; buy stocks in an operator. If you’re OK with lower returns, but want a higher degree of safety, a REIT is for you. Also, be aware that if you take stock picking advice from a CDC columnist you’re already in trouble.
