Top 5 Risks REITs Face
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Defending against cyberattack, attracting and training talented people and mitigating risk from macroeconomic forces are common challenges real estate companies face. REITs in particular may find it difficult to contend with these risks in addition to issues presented by engaging and managing third-party service providers and changing regulatory standards. We caught up with Baker Tilly partner Monica Dalwadi and senior manager David Jamiolkowski to learn about the top five risks REITs face.
REITs accrue a lot of sensitive and confidential information. As businesses go paperless, this information resides in the cloud rather than on tangible copies of documents locked away from prying eyes in filing cabinets.
“Credit card information, tenant financials and employees’ personal information can all be leveraged by hackers in nefarious ways for monetary or other gain,” Dalwadi said.
But for REITs, the stakes are much higher, as is the potential payout.
Victims will often acquiesce to hackers’ demands. They will pay by bitcoin rather than turn to law enforcement because they are desperate to recover the compromised information and because finding responsible parties hiding behind proxies often proves difficult.
“Arming employees with cybersecurity awareness and education courses, as well as secured backup technologies, can help prevent this compromise,” Dalwadi said.
2. Rising interest rates and debt compliance
As interest rates gradually rise, REIT executives must strive to ensure their portfolio properties’ valuations and returns stay strong. They can lock in current rates with derivatives and fixed interest rate loans.
“They must be cognizant of the controls and processes around hedging and around debt compliance,” Dalwadi said. “They also need to model the effects of future interest rate changes.”
3. Brain drain: talent acquisition/retention
Succession planning well in advance of leadership’s retirement or flight is paramount for REITs. To remain competitive, they should commit to continuously cultivating talent.
“How do we evaluate compensation for current employees, determine who’s performing which activities, cross-train our people, make sure we have backups and bring forth the next generation of leaders?" Dalwadi said. "These are all pressing questions for REITs."
“Now, it’s not just the top-level people, the C-level executives, REITs are preparing, but the layer underneath,” Jamiolkowski added.
4. Changing revenue recognition standards
There are a number of new requirements for revenue recognition, and remaining compliant can be labor-intensive. Organizations, including REITs, must re-evaluate each revenue stream and how it is treated under the Federal Accounting Standards Board’s new accounting standards.
“People say the current revenue recognition standard is the most pervasive they’ve seen in their careers,” Jamiolkowski said.
Previously, formal and informal standards were industry-specific. Now, real estate transactions fall under the same all-encompassing rules as any sale to a customer or third party.
According to Jamiolkowski, the new rules are more principles-based, and represent a big shift in how REITs treat reimbursement income, operating expenses and real estate taxes.
“We’ve heard our clients compare the new revenue recognition rules to Sarbanes-Oxley in terms of the amount of work involved to become compliant,” Dalwadi said.
5. Use of third parties
As REITs become leaner, they rely on third parties for an expanding number of services. When third parties are responsible for essential systems and processes like IT, human resources and payroll, having the right controls and structures both at the third party and to monitor the third party is necessary.
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