This article is republished with permission from REITCafe.
Prison real estate investment trust (REIT) stocks have been volatile during recent weeks in the aftermath of the Bureau of Prisons’ (BOP) announcement that it would not extend or renew its contracts with private prisons. The U.S. Department of Justice determined that private prisons have lower security standards and are less effective at providing correctional services than facilities run by the federal government. Declining prison populations also factored into the decision. The GEO Group stock price fell 40 percent, and Corrections Corporation of America (CXW) fell 35 percent after the August 18 announcement.
At first glance, it appeared that the REITs would lose a sizable portion of their income since the federal government is their largest tenant. However, the BOP represents only part of the federal government total. The BOP accounted for 9.0 percent of CXW’s revenues and 13.8 percent of BEO’s revenues for the first half of 2016. In contrast, the U.S. Department of Homeland Security’s Immigration and Customs Enforcement Division represented 28 percent of CXW’s revenue and 18.2 percent of GEO’s revenue during the same period. The United States Marshals also accounts for 15.0 percent of CXW’s revenues. In addition to the federal government, both REITs own and operate facilities for a number of states, and GEO operates in several international markets as well.
The situation highlights prison REITs’ vulnerability to politics. This political risk is somewhat offset by the long-term nature of prison REIT contracts and the structure of many contracts where payment is guaranteed regardless of occupancy at the facility. The REIT values recovered in part on Friday and Monday as investors determined that the decision’s impact will not be short-term.
Several class-action lawsuits were filed this week, leading prison REIT stocks lower again. The lawsuits allege that the REITs and their managers made materially false or misleading public statements and/or failed to disclose the issues that made the Department of Justice unlikely to renew or extend its contracts.
The loss of BOP contracts will clearly hurt these REITs, but it is unlikely to cause unrecoverable damage to either company. The bigger risk emerging from this week’s events is whether other federal and state agencies will follow the same path as the BOP and what that would mean for prison REITs.
* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com.
** - 10 yr. Treasury Yield as of 8/26/2016.
