What Does a Data Center's REIT Status Mean for You? Find Out Here!
Hi. I'm Max Clark. I'm gonna get into the weeds on why this matters and what you should be aware of when you're evaluating data centers and service operators. Okay. What is a REIT?
Speaker 1:A REIT as a real estate investment trust. It is a classification of an entity. Why do you want to become a REIT? You have massive tax benefits if you're a REIT. REITs are not taxed as a corporation.
Speaker 1:They have a special tax classification that gives them the ability to not pay corporate taxes because they're passing the taxable income to their shareholders. If there's a threshold, the rates are required to pay. I think it's 90% of their taxable income to their shareholders each year. This is why rates are very interesting investments. You know, you can buy REITs and public equity markets.
Speaker 1:You can buy you can do private placements into REITs. They're very predictable in terms of what their stock price is based on the value of their assets and the income off those assets. Right. So I mean, outside of the commercial real estate blowing up, you know, post COVID here, they're very consistent and stable. And you know what you're getting when you buy into a REIT, into a refund.
Speaker 1:Now we talk about the benefits of a REITs, talk about the requirements of a REIT. There's 2 major requirements, and these are the 75% test and the 95% test. So the 75% test is 75% of the REIT's assets have to be real estate. So 75% or more. Right?
Speaker 1:So not 74.9, but it could be 76, 77, 78. And by the way, this happens quarterly. They they have to certify and test this quarterly. Right? So 75% of the value of the REIT's total assets must be real estate.
Speaker 1:It can be cash, cash items, investable securities. It could be investments in other REITs. You know, so the REIT can hold cash to be invested into real estate. It can hold other REIT, you know, holdings and securities. It can hold government securities.
Speaker 1:Right? But 75% of the REIT's assets have to be in real estate. So if the REIT has any subsidiaries, those subsidiaries also apply up into that REIT. Right. So you can't have an operating company doing something completely different because that asset and the income off that subsidiary then rolls up into the rate.
Speaker 1:So that's that's the first thing. Okay. So we have an asset test that 75% of the value of the total assets have to be real estate. The second thing is an income test. So 95% of the rates gross income has to be real estate income.
Speaker 1:Again, we're using keywords here. 95% of the REIT's gross income. So not triple gap adjusted EBITDA minus whatever blah blah blah. You know, funny business. Top dollars received money that goes into the bank account.
Speaker 1:95% of REIT's gross income must come from rents of real property interest and obligations secured by mortgages on real property or dividends from other REITs and gain gain from the sale or other disposition of real property. But there's no there's no carve outs here. 95% of the REITs income has to come from real estate. It defines, you know, what is qualifying income. Right?
Speaker 1:Rents from real property rents charges for services furnished in conjunction with rental of real property. So like you're like property management that comes along with managing a building, you know, classifies, right, as income for real estate or if you've got facilities and building management and engineering and things like that, that have to be there in order for the building, in order for you to lease the space like that all applies. You know, fixtures equipment built into it. There's carve outs for impermissible tenant service income and definitions for it. And this is this is why this is really important.
Speaker 1:Impermissible tenant service income is income received or accrued directly or indirectly by a REIT for generally non customary services furnished or rendered by the REIT to tenants of the property. Inter permissible sir tenant service income ITSI is not considered qualifying income for either that 75% of 95% tests. If ITSI exceeds 1% of a property's gross income by the way here's another gotcha If it is I exceed exceeds 1% of a property's gross income, all income attributable to that property is considered tainted and not included as qualified income on it for the income test. If 1% of a property's gross income is impermissible tenant service income, all income from that property is tainted and is impermissible. Okay.
Speaker 1:Why is this important? Data center operators. What do you get when you go to a data center company? Right. 1st and foremost, you rent floor space.
Speaker 1:You you license floor space. Almost exclusively. We'll call it a license on a lease because they licenses don't have tenant protections at least does. Right? So you license floor space.
Speaker 1:So you're paying for floor space. You're playing for power. You're paying for condition air conditioning. You're paying for security. You're paying for the generators.
Speaker 1:You're paying for network connection. Right? Maybe if it's a carrier neutral data center operator, you've got fiber optic connectivity across connect inside the facility that actually go to the actual network provider. But then, you know, you do whatever you want to. Maybe you're connecting to a cloud on ramp or you're a direct connect or you've got, you know, your traditional IP transit or you've got some sort of IP transit transport or MPLS, VPLS, SD WAN, whatever the heck you're doing right in that world.
Speaker 1:I'm sure, you know, we can talk about is that qualified or not qualified income? Who cares? The bulk of the revenue coming out of you at that point is 100% real estate. If that data center operator is now pushing into other things, if that data center operator has a network as a service offering where they're offering giving you private connectivity between some kind of fabric, you know, it's a pretty big, you know, code word, right? Where you've got a dynamic interconnection network platform for private networking.
Speaker 1:Right. Is that permissible or not permissible revenue? Well, it's a network. Is network real estate? Interesting question.
Speaker 1:Right? That's a simple example. What if that data center operator is telling you that they have a bare metal service offering? Bare metal is compute infrastructure. If they've got storage with that bare metal storage, it's hard drives.
Speaker 1:It's not real estate. It's hard drives. So if you were selecting a data center provider on the pretense that that data center provider has bare metal built into it or a network asset built into it, that data center provider, if they're a REIT, cannot cross a 1% threshold in that property for those services. So they could tell you that they've got this phenomenal bare metal infrastructure stack, and maybe they do. But guess what?
Speaker 1:They're never gonna cross 1% of their gross income on that property. Otherwise, they blow their REIT status, which is worth it. It's a death penalty for them. So now what does that mean for you? That means you could build a corporate strategy around the idea that you're gonna leverage this fancy logo data center's bare metal platform as part of your expansion and scaling infrastructure.
Speaker 1:And when push comes to shove and you go to contract it, you're going to find out that either they still have space and you can get it. You'll find out that they don't have capacity. They're not going to communicate why they don't have capacity. I can tell you that they don't have capacity and we're waiting for more capacity. I'm sorry, there's nothing there for you to order or they're going to refer you to a 3rd party that you haven't vetted, that you don't know, that you have no information about.
Speaker 1:And you have to contract with a third party directly. And maybe they've got some marketplace. But again, marketplaces don't qualify for permissible income, so they can't sell it to you under the existing paper. You have to go out and you have to get different paper and you have to go out and you have to do a contract separately. The way the rules and laws are set up, if a data center is a REIT and they're selling you a promise of service on top of real estate, you are getting marketing mumbo jumbo and, you know, smoke and mirrors, bait and switch, whatever you wanna call it.
Speaker 1:You are getting sold a promise, a dream, a thing that cannot exist at any scale. Now okay. Back up a second. If that data center property, again, 1%, this isn't a big threshold. Right?
Speaker 1:If it's 1% and they're doing a $100,000,000 a month in data center. I mean, do we have a building doing a $100,100,000,000? $100,000,000 a year is only $1,000,000 a year in permissible non real estate income. Right? So, it's a $1,000,000.
Speaker 1:It's $86,000 a month, average bare metal server. You're probably gonna be, like, $2,000 in a heartbeat if 43 servers they can have in their bare metal platform and not cross that 1% threshold, not accounting for any sort of bandwidth or storage costs. There's a lot of things in tech marketing that makes me crazy. This might be after discovering this and really digging into what was going on here. This might be one of the worst versions of tech marketing that I have ever seen, you know, released upon unsuspecting unknowing end users.
Speaker 1:So why does it matter? In most cases, it doesn't matter. Probably doesn't matter at all that your real estate provider, your data centers are is probably a great thing that your data center is a REIT. They can raise money efficiently. They can distribute income and dividends efficiently.
Speaker 1:They're gonna be able to get investors as a result. Those are good things for you. Investors as a result. Those are good things for you. If you've selected that provider because you think you're getting other things from them, you might be surprised when you actually try to go and get other things for them.
Speaker 1:So don't count on those other things as part of your data center selection process. That's the moral of the story. I'm Max Clark. If you've had an experience with us, one of the process. That's the moral of the story.
Speaker 1:I'm Max Clark. If you've had an experience with this one, if you've got personal experience, if you have run into this threshold where you've tried to provision something and it's caused a problem for you, I'd love to hear about it. Comment below. Talk to you later.
