Industry consolidation among major risks facing REITs

By Stuart Eisenberg, BDO

Despite mid-year gains that propelled REITs to outperform the broader market after a slow start to 2016, REITs are not resting on their laurels.

According to BDO’s 2016 RiskFactor Report for REITs, an annual analysis of the most recent 10-K filings from the largest 100 publicly traded U.S. REITs, the top three risks weighing on REITs’ minds this year include economic and market conditions, competition for assets and leases and failure to maintain tax-exempt REIT status.

The latest shakeup in the global markets comes from the recent EU referendum more commonly known as “Brexit.”

The industry is watching warily as stock markets weather persistent turmoil. This isn’t likely to wane in the near-term as investors and businesses react to the vote and global markets adjust to the economic ramifications of Britain’s unexpected departure.

It comes as no surprise that market volatility is a chief concern among REITs again this year. General and local economic conditions, including market disruption and lack of demand, are cited unanimously among REITs we analyzed for the fourth consecutive year.

This year, more REITs also pointed to debt and credit risks as key business concerns. Several factors contribute to this trend’s longevity, including volatility in the CMBS market, conservatism in the public bond markets and sections of the REIT market continuing to trade at a discount to net asset value.

Ninety-six percent of REITs cite risks related to indebtedness in their disclosures this year, up 21 percentage points from 2014 levels.

And credit risk, including credit rating and the ability to secure credit, is cited among 87 percent, an increase of 32 percentage points from 2014.

Concerns that the Federal Reserve might increase interest rates could have contributed to REITs’ unease around the availability of capital.

As high-yield investments, REITs could associate a rise in interest rates with a decrease in property values and impediments to distributable cash flows. Such fears might have subsided significantly in the wake of Janet Yellen’s recent announcements that the Federal Reserve would not increase its benchmark interest rate, nor is it likely to hike interest rates anytime soon.

REITs unanimously highlight competition and industry consolidation as a top concern, up from 98 percent last year and 94 percent in 2014.

In sectors crowded with small players — such as the single family home sector — an uptick in M&A could be restoring balance.

Reflecting a healthier seller’s market during the first half of 2016, fewer REITs — 88 percent — cite concerns around the inability to sell properties in response to market shifts, down from 93 percent the previous year.

Capital inflow from foreign investors more than doubled last year, and reached $91.1 billion in 2015. REITs appear to be feeling a squeeze in the marketplace as cross-border commercial real estate deals grow more common.

REIT disclosures mirror that trend closely, with 63 percent — more than double 2014’s levels — citing impediments to U.S expansion and growth this year.

The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) adds complexity to the tax landscape with many provisions that are both advantageous and burdensome for REITs.

Executives appear to be taking notice, with 100 percent citing failure to maintain REIT status or loss of tax incentives as a risk in their disclosures, and 69 percent citing accounting rule changes and financial reporting risks.

The FASB’s new lease accounting standard suggests even greater uncertainty for REITs.

The recent standard intended to bring greater transparency to companies’ lease assets and liabilities, but may create an environment where businesses are more inclined to buy properties than lease them. As the industry evolves at a rapid clip, the sector will contend with both familiar risks and new threats.

Anticipating and adapting to emerging business challenges is critical to any successful risk management plan for REITs as they navigate mercurial markets and an increasingly competitive marketplace.

Industry consolidation among major risks facing REITs : Real Estate Weekly