Introduction to REIT
Real Estate Investment Trust, or REIT, is an organization that gathers cash from investors and invests them in the construction and ownership of real estate buildings on their behalf.
Before starting off with the all the risk factors involved, do consider reading my blog on 7 Reasons Why REIT Are Excellent Investment For Long Term.
In line with the long term benefits, one should thoroughly understand the risks that are involved in the short term REIT investment and how you can mitigate them to your benefit.
6 Risks involved with REIT investment:
1. Local disturbances
Local disturbances like change in law, taxation, corporate comfort towards the real estate sector can cause a consolidation in the market valuations.
This sector prospers when the over economy of the country prospers. Any disturbance in the economy at a local or a global level can hamper the real estate sector, thus affecting the income cycle of REITs.
Local disturbance cause a short term decline in the returns over investment which needs to be duly considered while deciding your investment portfolio.
These downfall due to local disturbances can be hedged by diversifying the investment portfolio over multiple assets in order to provide a cushion for the REIT breakdown.
2. Global recession
A recession can be defined as a time of transitory economic contraction marked by a decrease in commerce and industrial activity, as evidenced by a drop in GDP.
A recessions are generally hard to predict, which can disturb the demand supply equilibrium, thus reducing the market value of assets. For investors there can be situations where there is no proper liquidity to exit positions, thus affecting the net returns.
It may be a good time to buy a REIT units for a long term, considering they are available for a much lower market valuations as compared to their intrinsic value, as well as it can be good time for portfolio diversification.
3. Choosing the wrong REIT
Choosing the right REIT requires a good market and real estate knowledge. A REIT appreciates itself from the rental income it generates from the assets in their portfolio.
Thus, these rental income are again dependent on factors like the location of the project, its strategic importance, influence of the asset over people and commercial value with time.
Trend and craze for REITs may vary over time. One also needs to investigate these properties or assets to ensure that they will still be relevant and capable of generating rental revenue in the future.
4. REITs that are not publicly traded
There can be cases when the REIT units one has purchased may not be traded on secondary markets like NSE or BSE. In this scenario, the unit holder needs to wait for the private REIT entity will open the window for investors to buy and sell REITs.
In fact, this may be risky in the event of recession where investor cannot liquidate their assets which may continue to under perform with time, there by taking away all the gain accumulated over a period.
5. Investing in a wrong time
REITs just like stocks, are dependent on the psychology of people who trade those assets. The value of these REITs which are traded in the secondary markets are mostly dependent on the demand and supply.
A positive economic news can be enough to trigger a high demand in the market. This demand can push the price to unrealistic valuations. The investor needs to understand this risk and avoid in the momentum trading of REIT units.
Be fearful when others are greedy, and greedy when others are fearfulWarren Buffett
6. Lack of diversification
Having a proper REIT diversification requires a sizable capital. Most retail investors may be able to to invest in a handful of REITs, thus exposing it to high risk.
The property that was once considered a good source for revenue generation may not stand the same over a course of time. Having a diversified REIT portfolio will allow your net returns to stay positive even if one REIT fails to deliver the expected returns.
The best way to mitigate this risk can be by selecting mutual funds that invest in REITs and infrastructure projects. Thus, your capital will now be distributed in multiple projects and reduce the unpleasant volatility due to economic disturbances.
Before starting your REIT investment, one need to also understand that investing in REITs may be a low-risk, high-return alternative to owning property indirectly for long term. They should not influence investors as they can also under perform in the market of rising interest-rate environment.
Summing up the blog post:
|Sr No||Risk Identified||Mitigation Plan|
|1||Local disturbances||Proper hedging your overall portfolio with different assets.|
|2||Global recession||Diversify the overall portfolio in different sectors|
|3||Choosing the wrong REIT||Consult a financial advisor or a property valuer. Read research reports before investing.|
|4||REITs that are not traded||Invest with a long term mindset|
|5||Investing in a wrong time||Avoid herd mentality.|
|6||Lack of diversification||Switch to mutual funds that invest in REITs and infrastructure|