Since REITs vary across different sectors within real estate the capital intensity varies depending on the property types, but overall the industry has a medium-heavy capital intensity. Companies that are in this industry have to maintain their real estate and have big capital spending and D&A that takes up a big part of their investing activities. Along with the capital spending required to maintain their properties, acquisitions also take up a huge part of their spending. Over the next few years this trend should continue as the REIT industry continues to expand.
Technology and Systems
The REITs industry is facing many of the same challenges that most industries are facing related to tech dynamics, customer demographic shifts, and better and faster data access. Some of the main areas that real estate has been focusing on is operational performance and customer incentive and experience, and funding sources.
As the platforms for funding for tech start-ups become more stable you will start to see more of it. Some of the technologies that the start-ups are focusing on are data assemblage and the use of that data on a customizable platform that can help tenants, customers, and owners to reduce cost. As the data assemblage continues to get better there will be an automation technology shift towards cognitive automation. The data that is being assembled will be used to learn from and then utilize it.
On the contrary, technology has also been a persistent thorn in REITs sides as operational and competitive threats penetrate every segment of the real estate market. From an operational perspective REITs are becoming more reliant on information systems and technology. Ensuring that systems are running properly are important because almost 3 in 4 REITs say that they have had operational risks associated with the implementation and maintenance of technology and systems.
The more reliance that REITs have on technology means that there is an increase in cyber security threats. Different cyber threats include phishing scams, ransomware attacks, distributed denial of service (DDoS) and permanent denial of service (PDoS).
Prices of most assets are really high including mortgages. Spreads are very tight and in this kind of environment anything destabilizing could have big sell-offs. Long term interest rates are expected to be in between 2.50% and 3.00%, and with inflation under control, the increase will likely be modest. GDP is also expected to remain in the 2.2% to 2.5%. The continued moderate expansion in macroeconomic growth should support the continued moderate expansion in demand for REIT-owned properties. Property prices have risen 52% over the past five years, and are 23% above the peak reached prior to the financial crisis. Prices have slowed over the last 12 months, which has alleviated some of the concerns about the possibility of overheating.
Regulation and Policy
Depending on the sectors within REITs participants are required to meet various building and safety codes before being able to proceed with income property or mortgage loans. Regulations generally relate to handicap accessibility, fire codes, zoning restrictions and general construction standards, and construction firms must adhere to environmental standards, such as minimums for the amount of waste material recycled on the building site. In addition, various laws and regulations impose liability on real property owners or operators for the cost of investigating, cleaning up and removing property contamination caused by hazardous or toxic substances. A strong example of this type of regulation relates to the use and cleanup of asbestos, particularly within older buildings.
Real estate companies and developers can elect to be taxed as a real estate investment trust (REIT) under Section 856 through 860 of the Internal Revenue Code. As a REIT, these organizations must distribute, at minimum, an amount equal to 90.0% of taxable income and must distribute 100.0% of taxable income to avoid paying corporate federal income taxes. REITs are also subject to a number of organizational and operational requirements to retain their REIT status. They must be structured as a corporation, business trust or similar association and be managed by a board of directors or trustees. They must derive at least 75.0% of their gross income from rents or mortgage interests and at least 75.0% of their total investment assets must be in real estate. If an organization fails to qualify as a REIT in any taxable year, the organization will be subject to federal income tax on taxable income at regular corporate tax rates. Even if the organization qualifies for taxation as a REIT, it may be subject to state and local income taxes and to federal income tax and excise tax on its undistributed income.
The industry doesn’t receive direct benefits but it does benefit indirectly from government programs that improve lending practices. To improve lending, the federal government launched the $700 billion Trouble Asset Relief Program (TARP), which focused on strengthening the financial sector by purchasing assets and equity from financial institutions.
In addition, investors of REITs prefer to have it inside a tax-deferred account (such as a retirement account) in order to defer paying taxes on the dividends received and any capital gains incurred from the REIT until they start withdrawing money from the account.
Charlie Izaguirre contributed to this report. For a detailed list of sources, click here.