Capital Markets & Regulatory Shake-ups Ruffle REIT Feathers, BDO Study

New administration, sharing economy and e-commerce among emerging risks

CHICAGO--()--2017 is leaving a string of broken stock market records in its wake, but REITs have seen more modest boosts in performance. REITs registered 3.41 percent annual growth in early-June, compared to the broader S&P 500’s 9.91 gains. According to the 2017 BDO RiskFactor Report for REITs, competition for assets at lucrative prices, the anticipation of tax reform and the likely drumbeat of interest rate hikes rank high on REITs’ risk radar.

The top 100 REITs unanimously cite access to capital, financing and liquidity as a risk to their business, up from 96 percent in 2016 and 93 percent in 2014. REITs are bracing for the impact of multiple interest rate increases, which REITs worry could lead to restricted access to equity and more expensive debt in the long term.

“After enjoying several years of growth following the economic crisis, investors are beginning to take a more cautious approach,” said Stuart Eisenberg, partner and national leader of BDO’s Real Estate and Construction practice. “A potential slowdown in the market, combined with concerns of rising interest rates, a lack of continued access to capital, and disruptions in several REIT sectors, has added to the uncertainty. For REITs navigating the current economic environment, there is a real possibility this confluence of factors may result in slower growth.”

The following chart highlights the top risk factors cited in the most recent SEC 10-K filings from the 100 largest U.S. REITs:

                         

Top 20 Risks for REITs

      2017       2016       2015
General economic conditions, including disruptions in the financial markets       #1   100%       #1t   100%       #1t   100%
Access to capital, financing and liquidity       #1t   100%       #8t   96%       #3t   99%
Failure to qualify as a REIT       #3t   99%       #1t   100%       #1t   100%
Federal, state and local regulations       #3t   99%       #5t   98%       #10t   93%
Environmental liability       #5t   98%       #4   99%       #12t   92%
Interest rates & hedging       #5t   98%       #5t   98%       #6t   97%

Natural disasters, terrorism and geo-political events

      #5t   98%       #7   97%       #14t   92%
Industry consolidation & competition for lessees       #8t   97%       #1t   100%       #5   98%
Financial covenant restrictions       #8t   97%       #8t   96%       #8t   95%
Tax laws & rate increases       #8t   97%       #12t   94%       #3t   99%
Insurance risk & uninsured liabilities       #11t   96%       #8t   96%       #8t   95%
Indebtedness       #11t   96%       #8t   96%       #12t   92%
Capital improvements/renovation costs       #11t   96%       #14   93%       #17   88%
M&A, joint ventures and partnerships       #14   95%       #12t   94%       #6t   97%
Cybersecurity breaches       #15t   92%       #15   91%       #16   89%
Anti-takeover & change of control provisions       #15t   92%       #19   85%       #18   82%
Illiquidity of real estate investment       #17   90%       #16   88%       #10t   93%
Credit risk       #18t   86%       #17   87%       #19t   80%
Construction permits, costs & abandonment       #18t   86%       #18   86%       #19t   80%
Bankruptcy & property foreclosure       #18t   86%       #22   80%       #19t   80%
Declining values & asset impairment       #21   84%       #23   79%       #22t   78%
                       

Additional findings from the 2017 BDO RiskFactor Report for REITs include:

Changing of the Guards: REITs Adjust to the Trump administration

REITs are preparing for legislative, regulatory and tax changes under the nation’s 45th President, with tax and healthcare reform topping the list.

  • More than 1 in 4 REITs mention Trump by name in their 10-K filings.
  • Among those 26 REITs, Trump’s name is mentioned 59 times.
  • 44 percent list concerns related to the new administration.

Cybersecurity: A Whole New Ball Game for REITs

Technology risk has been a persistent thorn in REITs’ sides. From an operational perspective, REITs’ reliance on their information systems and technology has grown significantly. Ensuring the right systems are in place and keeping them in working order are top priorities in 2017.

  • Almost three-quarters (72 percent) cite operational risks associated with the implementation and maintenance of technology and systems, up from 43 percent in 2014.
  • More than 9 in 10 REITs (92 percent) identify cybersecurity as a threat in their disclosures, up from just 25 percent in 2012.

Proposed Tax Reforms High on REITs’ Radar

With tax reform on the table—and the White House’s initial tax framework announced—REITs are simultaneously assessing the impact proposed reforms could have on their business models and implementing changes to comply with IRS requirements going into effect at the end of the year.

  • 97 percent cite risks related to tax laws and potential increase in rates, up from 85 percent in 2014.

No Vacancy: Hospitality REITs Tackle Disruption

With the growth of the sharing economy, the name of the game has become instant gratification: Space sharing and growing demand for shorter-term commitments are shaping the future for the retail, hospitality, office, apartment and timeshare sectors.

  • 80 percent of REITs point to the sharing economy and the proliferation of online rental platforms, such as Airbnb, HomeAway and VRBO, as a threat.
  • 80 percent cite the growing popularity of third-party Internet intermediaries, like TripAdvisor, as a risk to their business—primarily as a barrier to maintaining strong brand loyalty.
  • 73 percent cite loss of franchise license.

REITs Underestimate Lease Accounting and Revenue Recognition

Internal controls and financial reporting risks and accounting rule changes are cited by 71 percent of REITs, up from 69 percent in 2016 and 50 percent in 2014. The newly finalized Lease Accounting Standard, ASC 842, which will take effect in December 2018, is particularly key for the commercial real estate sector.

  • Just 15 percent of REITs specifically noted lease accounting in their filings, consistent with 2016 levels.

“REITs may think the lease accounting and revenue recognition standards won’t significantly impact them, but they may be surprised,” said Angela Newell, national assurance partner at BDO USA. Applying the new standards can be complicated, and organizations that aren’t making headway on an adoption plan—establishing it and putting resources behind it—risk falling behind.”

The 2017 BDO RiskFactor Report for REITs examines the risk factors in the most recent 10-K filings of the largest 100 publicly traded U.S. REITs; the factors were analyzed and ranked by order of frequency cited.

About BDO

BDO is the brand name for BDO USA, LLP, a U.S. professional services firm providing assurance, tax, advisory and consulting services to a wide range of publicly traded and privately held companies. For more than 100 years, BDO has provided quality service through the active involvement of experienced and committed professionals. The firm serves clients through 63 offices and more than 450 independent alliance firm locations nationwide. As an independent Member Firm of BDO International Limited, BDO serves multi-national clients through a global network of 1,408 offices in 154 countries.

BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. For more information, please visit: www.bdo.com.

Contacts

Bliss Integrated Communication
Kerry Mullen, 212-840-1661
kerry@blissintegrated.com

Contacts

Bliss Integrated Communication
Kerry Mullen, 212-840-1661
kerry@blissintegrated.com