Why Betting On REITs Could Be Risky Now - Sept. 2017

The use of leverage for real estate investment trust (REIT) businesses makes the returns from this industry susceptible to interest rate movements. This is because a rise in the interest rate affects the present value of future cash flows. Therefore, asset valuation, including bond coupons and stock dividends, experiences a decline.

In addition to this, weakness in the fundamentals of certain asset categories has added to the woes because it further restricts the scope of enhancing the future cash flows from the properties of the corresponding REITs. Specifically, changes in consumer preferences and supply issues in a number of asset classes have affected the market fundamentals and are likely to continue thwarting growth of REITs in the coming months.

Therefore, prior to making any investment in this special hybrid class, one needs to pay close attention to all the weakness.

Fundamental Weakness

Retail REIT

Particularly, mall traffic continues to suffer amid a rapid shift in customers’ shopping preference through the online channel, resulting in an increasing number of retailers jumping on the dot com bandwagon. These have made retailers reconsider their footprint and eventually opt for store closures in recent times. In fact, the decision to close stores by a number of reputable retailers like Macy's, Inc. (M - Free Report) , J. C. Penney Company, Inc. (JCP - Free Report) and Sears Holdings Corporation , have raised concerns over cash flows of mall landlords.

Further, retailers unable to cope with competition have been filing bankruptcies. This is a pressing concern for retail REITs, as the trend has been considerably curtailing demand for the retail real estate space.

This choppy retail real estate market situation is also said to have led to tenants demanding substantial lease concessions, which mall landlords are finding unjustified. Moreover, significant store closures in the middle of the lease term not only hurt mall landlords, but also the tenants occupying space in that mall because their shop visits also depend on the mix of specific types of retailers.

Amid these, retail REITs are fighting back and giving their malls a facelift in an attempt to lure customers. They are also adopting the latest technologies to offer attractive services to their tenants and mall visitors as well as transforming their traditional retail hubs into entertainment destinations. However, the implementation of such measures requires a decent upfront cost and, hence, is likely to limit growth in the profit margins of retail REITs in the near term.

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