Economy and Capital Remain Biggest Risks for REITS in 2014

While general economic conditions continue to be the No.1 risk factor self reported by real estate investment trusts (REITs) for three years in a row, according to the latest BDO RiskFactor Report, other concerns, such as cyber security, are now more prevalent than in years past.

Despite the challenges and uncertainties around the economy and other factors, such as interest rates, senior housing REITs have expressed they are eager to continue investing in a rising interest rate environment.

Healthcare REITs have been heavy-hitting investors in the senior housing space, benefitting from a low cost of capital leading them to massive, billion-dollar portfolio transactions.

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In the first half of 2014, Health Care REIT (NYSE: HCN) generated more than $500 million in new investments. In the second quarter of this year, HCN has completed more than $400 million in new investments.

But while REITs have remained hungry for senior housing properties, they are not without risks, BDO found in its survey of publicly held REITs this year.

The 2014 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, health care REITs included. The factors are analyzed and ranked by order of frequency cited.

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Cyber security risk jumped to 63% this year, up from 39% in 2013 and 25% the year prior.

“While this risk may be a larger issue for other industries, such as retail, which has enormous amounts of consumer data, and technology, which has highly sensitive information, it is clear that REITs are paying close attention,” BDO says.

The top five risk factors REITs reported this year following general economic conditions are failure to qualify as REIT, ability to make distributions; strong competition for lessees and prime real estate; inability to acquire capital or financing; and increases in interest rates, hedging rates, respectively.

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In addition to cyber security, other risks for REITs that jumped in prevalence compared to years past include financial condition of tenants, increasing steadily from 71% in 2012, to 75% in 2013 and 79% in 2014; along with property foreclosure and bankruptcy, increasing from 65% last year to 73% this year.

“The increase in REITs citing [financial condition of tenants as a risk] is likely related to the difficulty of attracting financially sound tenants,” BDO says. “Closely linked to this fear is the risk of property foreclosures, which remain relatively high in certain states like New York, Illinois and Oregon, according to MarketWatch.”

The report also shows that insurance risk may cause underwriting challenges, as 87% of REITs cite inadequate insurance and uninsured liabilities as a risk this year.

With the Terrorism Risk Insurance Act (TRIA) slated to expire at the end of the year, some lenders are eyeing short-term underwriting obstacles for many REITs should TRIA not be renewed.

“The expiration of TRIA is causing quite a bit of anxiety in the REIT industry,” says Clark Schweers, principal at BDO Consulting, in the report. “This stop gap insurance is extremely important especially to the REIT community to make sure that the appropriate risk transfer products are available at a reasonable price point and with appropriate limits to serve the industry.”

Concern over natural disasters, war and terrorism, perennial contributors to REITs’ insurance concerns, also remain top of mind, with 85% of REITs noting it as a risk this year.

“The frequency and severity of fires, earthquakes and hurricanes is above the historical norm,” Schweers says. “Therefore, it is not surprising that many in the REIT community are concerned about the impact of weather on their assets.”

Read the full report here.

Written by Cassandra Dowell