Much has been written recently about the decline in REIT share prices with most of the blame attributed to rising interest rates or the fear of rising interest rates. Some pundits see rising interest rates as a problem while some do not. Most of the analyses reviewed focus on whether or not rising interest rates are a problem for REITs but, that type of analysis may fall very short of identifying the real risks faced by REITs.<\/p>\n
Most analysts would probably agree that the great advantage of REITs is liquidity followed by shelter from income taxation (the REIT pays no income tax if it distributes the statutory amount to shareholders). Neither of these advantages is impacted by interest rates and will survive regardless of whether rates are high or low. But, an analysis of the effect of rising interest rates must go further.<\/p>\n
The very low interest rates in the last few years have caused capitalization rates to fall to a historically low level.\u00a0 The capitalization rate (cap rate) is the rate of return that is used to convert net income into value by dividing that net income by the rate. Historically, as rates fall values rise and conversely as rates rise values rise.\u00a0 Hence, rising interest rates can trigger a reduction of individual and portfolio property values. This, in turn can impact share prices. This effect can be immediate.<\/p>\n
Rising interest rates will force debt service to increase at the time of re-finance which, in turn, may reduce the cash flow available for distribution? This is not an immediate problem and is often postponed until refinancing is necessary.<\/p>\n
However, interest rates are not the only REIT problem and the lack of analytical research on other potential problems for REIT investors may result on causing the focus to be limited to a simple issue rather than seeing the range of potential issues.<\/p>\n
Management:<\/span><\/b>\u00a0 One analyst observed the contribution of management as \u201cacquisitions, dispositions and development\u201d as well as \u201ceffective capital allocation\u201d. There is no doubt of the importance of these skills.\u00a0 However, much more important and rarely discussed is the \u201coperating management\u201d skill of the management team.\u00a0 Properly managing the day to day operations of each individual property includes; effective tenant retention, effective leasing and rental programs, minimizing vacancy risk, strong preventive maintenance programs and rigid control over operating expenses to name a few. Most analysts fail to offer any analysis of these important functions as contributors to dividends and value. Unfortunately most REIT investors have no means for evaluating management and, thus face a risk that management shortcomings could negatively impact performance.<\/p>\n Portfolio Diversification<\/span>: <\/b>Many REITs are sector REITs (investing in one type of property like offices, apartments etc) rather than being diversified into different property types.\u00a0 There are good arguments pro and con on this subject. However, the fact is that not all property types can be expected to perform in the same manner in all types of economic circumstances. For example, Power Centers (\u201cbig box\u201d retailers) face consolidation problems like the merger of Office Max and Office Depot or failure. The preferred means of achieving diversification is to own REIT shares in the various sectors.<\/p>\n Local Nature:<\/span><\/b> Individual real estate is locked into its location.\u00a0 It can\u2019t be moved to another part of town or to another city. Many REITs are geographically concentrated and not all geographic areas can be expected to perform in the same manner. REIT investors need to consider the potential positives or negatives of ny geographic concentration.<\/p>\n Vacancy Exposure:<\/span><\/b> One of the greatest risks of real estate ownership is the constant exposure to vacancy by virtue of lease expiration, tenant bankruptcy or tenant failure. Many REIT report their lease expiration schedule but few, if any, disclose the renewal probabilities for specific large tenants until the tenant has made some form of public announcement.<\/p>\n All of the foregoing problems, in addition to the interest rate problem are things that should be of concern to REIT investors and the need for information may be an opportunity for some analysts to find an unfilled niche.<\/p>\n","protected":false},"excerpt":{"rendered":" Much has been written recently about the decline in REIT share prices with most of the blame attributed to rising interest rates or the fear of rising interest rates. Some pundits see rising interest rates as a problem while some … Continue reading