REIT competition is increasing, says Stuart Eisenberg at BDO's Chicago offices.

CHICAGO—Although general economic conditions and failure to qualify as a REIT remain the risk factors most likely to keep investment trusts’ leadership up at night, the executives have also been paying more attention to risks stemming from operating expenses and costs of capital improvements. That’s among the findings of locally based BDO USA LLP in its “2014 BDO RiskFactor Report for REITs,” based on analysis of the most recent 10-K filings from the 100 largest publicly traded companies in the sector.

The report found OpEx and CapEx in 82% of the 10-Ks this year, up from 77% in 2013. Also on the rise were concerns about the financial health of tenants, cited by 79% as a risk factor, compared to 75% the year prior.

Competitive issues continue to rank third, though, behind concerns about economic fundamentals and the risk of failing to qualify as REIT or make distributions to shareholders. For the second year in a row, REITs’ 10-Ks cited worries about competing for tenants or prime real estate. In 2012, third place was taken by worries about the inability to acquire capital or financing.

“Successful real estate properties are often dependent on two factors: the ability to secure strong lessees and the ability to secure adequate financing,” says Stuart Eisenberg, partner and real estate practice leader at BDO USA. “In the recent past, high unemployment numbers, low spending, limited capital and generally poor economic conditions exacerbated these risks across the entire industry. In this emergence period, we are seeing strong competition among real estate segments like high-end retail.”

BDO’s analysis addressed some of the other REIT bugbears, such as rising interest rates. Ninety percent of the 10-Ks analyzed by the firm cited this as a risk, up from 88% last year. “There are several concerns around the impact of rising interest rates as a result of the Federal Reserve’s tapering of quantitative easing practices,” according to BDO.

Notably, the firm says, “the potential negative impact on REIT returns, which could make other investments like bonds more attractive, especially if there is a sharp spike in interest rates and cap rates. However, a gradual move in interest rates is expected,” which would allow time for upward adjustments in rent and NOI, thereby mitigating the impact of increases in interest rates and cap rates.

Another risk cited more frequently in 2014 isilliquidity and an inability to sell properties quickly rose, which figured in 89% of 10-Ks this year compared to 82% a year ago. “Intensifying this risk is the increase in pricing rates,” according to BDO. “Properties are likely being priced to hedge against unfavorable cap rate adjustments, and appetites on the buy side may be lacking or unwilling to accept the pricing increase.”

The liquidity issues are “dichotomous” when comparing prime markets to secondary and tertiary ones. “In recent years, prime A markets, like New York and Chicago, offered attractive pricing on properties that were also likely able to continue to perform in a troubled economy,” BDO states. “Post recession, stability can be found in these markets but pricing may be inflated for current demand. Secondary and tertiary markets continue to face illiquidity challenges of an entirely different ilk—one in which debt financing remains scarce, even to acquire desirable assets.”