Top Risks for REITs in 2013

By Stuart Eisenberg, Partner & Real Estate Practice Leader, BDO USA, L.L.P., [email protected]

With demand for new homes increasing and confidence in the commercial real estate sector slowly being restored, the real estate industry seems to be poised for continued growth. In this environment, we analyzed the risk factors in the most recent 10-K filings of the largest 100 publicly traded U.S. real estate investment trusts to determine the top emerging or ongoing risks concerning industry leaders. 

Despite Improvements, General Economic Conditions Worry All REITs for Second Consecutive Year 

The BDO RiskFactor Report for REITs found that general economic conditions are a serious worry this year, with 100 percent of REITs citing it as a risk. While market conditions appear to be improving, there is a noticeable cautiousness around what that means and how long that will be the case, as there are a number of factors—regulatory changes, bank lending prudency and the overall business environment—that could be detrimental to the industry. On the other hand, there is now less concern over access to capital and financing, which decreased from 97percent in 2012 to 94 percent this year. This could mean that the real estate industry has survived the worst of the economic recession and is now showing signs of improvement.

Low Interest Rates Provide Favorable, Yet Risky Environment for Investors

Interest rates offered to investors on short and medium investments continue to trend near zero, creating a desirable environment for investors to place their investible assets in REITs. The Federal Reserve remains committed to keeping interest rates down as a strategy to promote borrowing, and quantitative easing is expected to continue through next year, possibly affecting rates until 2016. These favorable conditions could be leading to the decrease in REITs citing an increase in interest rates as a risk (88 percent this year, down from 92 percent last year). However, there is no guarantee that rates will not rise before then, which could have a material impact on the industry. For example, mortgage REITs are particularly susceptible to interest rate changes, and recent rate anxiety among investors has prompted some REIT share prices to drop. 

Strong Competition Drives Concern over Attracting Financially Stable Tenants

Strong competition for lessees and prime real estate is a top concern for 96 percent of REITs. The multi-family sector is a good example of where oversupply of rental units and less demand as a result of an improving single-family housing market are creating a challenging environment to attract lessees. This need to manage vacancy risk may be leading to developers battling it out to acquire properties in prime A real estate locations, which have a better chance of occupancy.  The CRE sector is also feeling pressure to shore up tenants, as many businesses continue explore ways to reduce occupancy costs. 

Emerging out of the economic crisis, the real estate industry faces new, rising challenges, despite the implications that overall market conditions are strengthening.  Today, knowing how to manage the variables of an evolving market –from interest rates, to supply and demand trends—in order to reduce risk and take advantage of opportunities on a timely basis, could mean the difference between long-term success and failure.