What are the factors affecting the Return of REITs?
- Pages: 5
- Word count: 1132
- Category: Interest Investment
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What are the factors affecting the Return of REITs?
REITs unit holders are subject to similar risks as holders of other diversified asset portfolios. Some of the factors which affect returns on REITs are :
Demographics are the data that describes the composition of a population, such as age, race, gender, income, migration patterns and population growth. These statistics are an often overlooked but significant factor that affects how real estate is priced and what types of properties are in demand. Major shifts in the demographics of a nation can have a large impact on real estate trends for several decades. Investors must narrow down the type and location of potentially desirable real estate investments long before the trend has started.
Interest rates also have a major impact on the real estate markets. Changes in interest rates can greatly influence a person’s ability to purchase a residential property. That is because as the interest rates fall, the cost to obtain a mortgage to buy a home decreases, which creates a higher demand for real estate, which pushes prices up. Conversely, as interest rates rise, the cost to obtain a mortgage increases, thus lowering demand and prices of real estate. However, when looking at the impact of interest rates on an equity investment such as a real estate investment trust (REIT), rather than on residential real estate, the relationship can be thought of as similar to a bond’s relationship with interest rates. When interest rates decline, the value of a bond goes up because its coupon rate becomes more desirable, and when interest rates increase, the value of bonds decrease. Similarly, when the interest rate decreases in the market, REITs’ high yields become more attractive and their value goes up, thus affecting the market price of REITs.When interest rates increase, the yield on an REIT becomes less attractive and it pushes their value down.
Another key factor that affects the value of real estate is the overall health of the economy. This is generally measured by economic indicators such as the GDP, employment data, manufacturing activity, the prices of goods, etc. Broadly speaking, when the economy is sluggish, so is real estate. However, the cyclicality of the economy can have varying effects on different types of real estate. For example, if an REIT has a larger percentage of its investments in hotels, they would typically be more affected by an economic downturn than an REIT that had invested in office buildings. Hotels are a form of property that is very sensitive to economic activity due to the type of lease structure inherent in the business. Renting a hotel room can be thought of as a form of short-term lease that can be easily avoided by hotel customers should the economy be doing poorly. On the other hand, office tenants generally have longer-term leases that can’t be changed in the middle of an economic downturn. Thus, although you should be aware of the part of the cycle the economy is in, you should also be cognizant of the real estate property’s sensitivity to the economic cycle.
Legislation is also another factor that can have a sizable impact on real estate property prices which might impact on returns on REITs.Tax credits, deductions and subsidies are some of the ways the government can temporarily boost demand for real estate for as long as they are in place. For example, in 2009, the U.S. government introduced a first-time homebuyer’s tax credit to homeowners in an attempt to jump-start home sales in a sluggish economy. According to the National Association of Realtors (NAR), this tax incentive alone led to 900,000 homebuyers to buy homes. Differences in generally accepted accounting principles, or local economic or political events in the countries in which those properties or investments are located also affect the returns on REITs.
5.Wear and tear, and disasters which damage physical real estate assets owned by the REITs.
6.Professionalism & experience of the property management firm.
7.Quality of assets owned by the REITs, essentially affecting sustainability and stability of revenues; the better the quality, the higher the rental income and occupancy rates the REITs can secure.
8.The length of lease the property management firm can secure and the confidence of the tenants.
The consistent contribution to returns based on increasing asset growth can be attributed to the ability of acquisitive REITS to obtain bargains in the real estate property market. In addition, growth of the asset base allows for some firm level economy of scale for organizational level expenses. REITs have in some cases increased their size by merger with other REITS as well as by engaging in development opportunities. Capacity to grow by either method is an endorsement of the strategy of the REIT and brings the reward of higher returns. 10.Total Preferred
The positive impact of increasing levels of preferred stock can be explained by considering the distinctions between preferred stock and debt. If the firm experiences financial distress, it has greater flexibility to protect cash flows by suspending payment of preferred dividends. Suspension of preferred dividend payments is not a default, while failure to pay interest on debt is a default. This increased flexibility accounts for higher returns since the firm is able to pursue valuable opportunities with a more flexible capital structure. 11.Variable debt
Variable rate debt poses the risk of increasing interest rates and the resulting uncertainty to cash flows. Penalization of returns based on this variable is likely in view of the reduced ability of the firm to exploit opportunities and the increased exposure to rising interest rates.
Mortgage REITs buy regular mortgage-backed securities the same way that any investor could. But rather than simply taking money they have, buying mortgage securities, and then calling it a day, mortgage REITs go out and
borrow as much money as they can to buy additional mortgage securities, hoping to profit on the spread between the interest rate they pay to borrow and the interest rate they earn on their mortgage-backed securities. Given that the Federal Reserve has gone out of its way to keep short-term rates as low as possible over the past several years, mortgage REITs have gotten a nice boost.
But the implementation of QE3 could eventually have an adverse impact on the long-term prospects for mortgage REITs. The Fed said that in its bond buying, it would focus on mortgage-backed securities — the same ones that mortgage REITs seek to invest in. As a result, prices for mortgage-backed securities will inevitably rise. That’s good news for the existing portfolios mortgage REITs own, but it will make it more costly for mortgage REITs to invest in new securities, cutting margins and making them less profitable.