Environmental Liability Climbs in REIT’s Risk Ranking

99% of REITs Cite Environmental Risks in 10-Ks vs. only 91% Four Years Ago

Real estate investment trusts are the most active buyers and sellers of commercial properties, making them the strongest growth market for property due diligence professionals today. Just in the first quarter of 2016, REITs sold more than $15 billion in commercial properties and bought less than $6 billion, according to CoStar. Research firm BDO just released its 2016 Risk Factor Report, ranking the top 20 risk factors that REITs face, and this year’s risk ranking reflects some interesting shifts in focus. Among them is the rise in environmental liability risk, which landed itself in a top five spot this year due to the increasing emphasis being placed on green building and sustainability.

BDO Ranks REIT Risk Factors

BDO USA’s 2016 Risk Factor Report for REITs contains an analysis of the risk factors in the most recent 10-K filings of the largest 100 publicly traded U.S. REITs, and ranks them by order of frequency cited. The 10-K disclosures are interesting in that they demonstrate the breadth of business risks and challenges facing REITs today, as well as highlighting the ones that present the highest concern. Based on the findings, the top three most-cited risks are general economic and market conditions, failure to maintain REIT status, and strong competition for assets and leases.

RiskFactors

Environmental Liability Is Top 5 Risk Factor

In fourth place, appearing for the first time as a top 5 risk factor, is environmental liability. Nearly all REITs (99 percent) cite environmental liability as a risk of doing business, up eight percentage points from 91 percent four years ago and 92 percent last year. Interestingly, environmental liability beat out other risk factors, like access to capital (tied for #8), an inability to sell properties quickly (#16) and development and construction risks (#18).

Concerns related to environmental liability are heightened by the greater focus on green building and sustainability, particularly as they relate to corporate social responsibility. Recent studies have found that tenant demand is stronger for environmentally-friendly properties, and that investors are championing green companies as part of their socially responsible policies.

Now that the market is in the peak of commercial real estate loan maturities, REITs also face the daunting task for shopping around for capital for refinancing. As old property loans seek refinancing, REITs are vulnerable to any environmental impairments at their property that could adversely impact its value. In addition, old environmental due diligence reports are surfacing with issues like vapor migration risk that raise eyebrows today but may not have been a focus when the loan was originated 7 to 10 years ago.

Natural Disasters, Cybersecurity, Credit Risks Also Jump in Risk Rankings

The BDO study also highlighted a number of other noteworthy jumps in the risk ranking, including:

  • Natural disasters, health epidemic, terrorism and geo-political events; climate change (cited in 97% of filings vs. only 83% in 2012), reflecting the impact of recent high-profile terrorism events, as well as more common extreme weather events that can slow market activity or impede the use of certain properties.
  • The biggest four-year jump is for risks associated with security breaches (cited by 91% of 10-Ks vs. only 25% in 2012).
  • Credit risk, including credit rating and ability to secure credit, is also a growing concern today (cited by 87% of 10Ks vs. 53% in 2012).
  • Fewer REITs this year (88 percent) cite concerns around an inability to sell properties quickly in response to market shifts, down from 93 percent in 2015—reflecting a healthier seller’s market.

Growing Opportunity

Based on the economists who spoke at last week’s MBA of NY real estate summit, property markets are healthy and demand for commercial space is increasing in the face of moderate economic growth, and continued low interest rates. REITs are expected to continue to be the headline makers in today’s property deal making world, sharing the spotlight with foreign investors, which purchased a record $91.1 billion in U.S. properties last year, more than double the amount they purchased in 2014. This trend isn’t set to reverse anytime soon.

The risks that surfaced in BDO’s study are not unlike the concerns that any real estate investors face today face: competition for prime real estate and concerns about any issues, including environmental conditions, that could adversely impact their holdings and impede their ability to refinance their maturing property loans. With REITs, property due diligence professionals have a win-win situation:

(1) a target market for their services that will dominate this year’s news on property acquisitions, and

(2) a sector that recognizes the risk that environmental issues pose to property value.

REITs have also become more aggressive in selling properties, especially trophy properties in markets where values have appreciated, and then using proceeds to close property deals in other metros where they see stronger buying opportunities. These factors are strong reasons why anyone looking for new opportunities should pay attention to this important sector of the commercial real estate industry and identify key players to target in their area of operation.

FOR MORE INFORMATION

The 2016 RiskFactor Report for REITs reveals that while REITs are recovering from a slow start to 2016 and enjoying healthy gains, the industry is contending with not only familiar risks but also new threats. Any due diligence professionals with REIT clients can access the full report here.