What Are REITs Afraid Of?

CHICAGO—The new remake of the 1982 horror thriller Poltergeist is being advertised with the tagline, “What are you afraid of?” In the case of REITs, the most fearsome boogeyman for 2015 may be interest rate increases. That's according to BDO USA LLP's analysis of risk factors cited in the most recent 10-K filings by the nation's 100 largest publicly traded REITs.

Although not cited as a risk factor by all 100 of these REITs—unlike general economic disruption and failure to qualify as a REIT, both of which have been cited year after year—an increase in interest rates and hedging does appear in 97% of their latest 10-Ks, up from 90% in 2014. A substantial rate hike by the Federal Reserve would have far-reaching implications for real estate trusts.

“Low interest rates have contributed to the REIT industry's expansion in recent years, and if an increase in interest rates were to occur, the industry's access to capital to fund future growth may be impacted,” says Stuart Eisenberg, partner and real estate practice leader at BDO. He adds, though, that “this could be offset by both strong economic fundamentals and a lack of attractive alternative investments that provide an acceptable risk adjusted return.”

Also cited by 97 of the top 100 REITs is risk associated with mergers and acquisitions, joint ventures and partnerships. That concern saw an even bigger increase in frequency compared to last year, when 85% of the REITs cited M&A risks.

“REITs are eager to grow their portfolios through M&A activity especially as interest rates remain low. However, with such high demand and not enough quality product, many REITs are taking a differentiated approach to securing additional properties,” says BDO's Anthony La Malfa, a partner in the firm's real estate & hospitality services group. “Many REITs are chasing deals and choosing to round out their portfolios with properties in secondary and tertiary markets and others are using innovative deal structures to remain active in their focused markets.”

Tax issues can and do arise as a result of M&A transactions, and that goes a long way toward explaining why more REITs are worried about tax laws and increases in taxes. Ninety-nine percent of the REITs analyzed by BDO mention tax laws and increases in rates as a risk, up from 85% a year ago. In addition, risks related to internal controls, financial reporting and accounting rule changes are being cited more frequently this year: 73% of the most recent 10-Ks do so, up from 50% in '14 and 36% in 2013.

Changes to the regulatory regime and economic conditions aren't the only factors keeping top REIT executives awake at night. With greater uncertainty globally around both weather patterns and man-made violence, 90% of REITs cite natural disasters, war, conflicts and terrorist attacks as risks this year, up from 85% in '14.

These potentially business-interrupting events may dovetail with increasing concern about inadequate insurance. Ninety-five out of 100 REITs cite this as a risk, up from 87 a year ago. Similarly, the headlines about cyberattacks on Sony Pictures, Home Depot and other large organizations have REITs more concerned about security breaches: 89% of the latest 10-Ks cite this as a risk factor, up from 63% in '14 and just 39% two years ago.