Calgary real estate investors sometimes turn to alternative markets when times get tough. At present, property investors are more apt to place their funds in Real Estate Investment Trusts, or REITs for short. But these investments are not without risk. Here are some to look out for.
Consider Interest Rates
Of course you should look at interest rates when investing in a REIT. That is a prime focus for most sales, even though most people don’t pay attention to those rates until it’s time to renew a mortgage. The debt on a REIT does not mature each year, except for only about eight to ten percent. Interest rates are low currently, so most with REITs extend the debt duration so the subject won’t come up for between seven to ten years, rather than the normal five or six.
What About Recession?
Recession is a concern and can be a risk for REIT investors. Commercial real estate demand tends to diminish. Companies, rather than expanding, are reducing their space, as well as their employment rolls. If you have a lease that is expiring, the company may not choose to re-up that lease because they just don’t need the space. That brings the occupancy rate down, and eventually the rental rates, both of which impact your wallet. Currently, North America’s economy is growing at about two percent per year, which is considered a rather high risk. Comfortable growth is considerable higher.
Knowledge vs. Confusion
REITs are riskier if you are not all that familiar with the real estate market. Some people are concerned about earnings which have little meaning with an REIT. It’s hard to compare real estate investments, not at all like looking at one company as opposed to another.
Using a newspaper as an example, we see that printing presses are only good for so many printings before they wear out. That is a depreciation cost you can work your head around. In real estate, say you build a complex for a cool $1 billion. Some 40 years hence the value will most likely have increased, even though the books give it a value of $0. In the newspaper business the assets appreciate, but the value decreases. In the real estate market, the assets depreciate, but the value increases.
All of this comes down to cash flow. Earnings in a newspaper are nothing like the cash flow of a real estate investment. Understanding the cash flow metric will help you figure out your real estate earning power.
Expand Your Vision – Go Beyond That Tunnel
If you are planning in getting into an REIT, don’t put all the investments in one part of the country. The REITS that perform the best have funds scattered across the various geographical locales in Canada. Also of importance are leverage, payout ratio, strategy and the management of your assets. Look particularly at that payment ratio. If it is costing you more to maintain a property than the money that property brings in, that is an unsustainable situation. It’s even worse if your leverage level is too high, with not enough ready cash to fall back on. Bottom line is do your homework, and ask for help from a qualified individual or firm if you need to.