Property investment has traditionally been regarded as a ‘safe’ investment. Whether or not that is still true in today’s market environment is a discussion for another day. But since REITs are like a hybrid of stocks and real estate, their risk profile carries elements of both.

Here are the six key risks you should be aware of before investing in REITs.

Risk #1: Market Risk

This one is simple. Because REITs are publicly traded like stocks, their prices fluctuate based on market forces. While traditional property prices also move around, you typically do not know the exact value of the property until you actually try to sell it. With REITs, you will know exactly what the market has valued it as.

Risk #2: Liquidity Risk

As we mentioned in Part 1, it is very easy to buy and sell REIT shares almost instantly so long as the market is open—the REIT’s shares are liquid. However, that is not the case for the properties the REIT owns. Economic difficulties may result in a REIT having to sell some of its portfolio. But that will not be easy to do and that may have a negative effect on the REIT’s share prices and dividend income.

Risk #3: Business Risk

The properties the REIT owns—whether malls, hospitals, or hotels—are each businesses in their own right. Thus, they face the normal risk of the business failing to perform. As an example, just think of an empty mall or a sparsely occupied hotel. If those are owned by a REIT, that REIT will be negatively affected.

Risk #4: Refinancing Risk

Refinancing risk is the risk that a REIT will not be able to meet its loan obligations or obtain refinancing. If this happens, without external support (e.g. from a strong sponsor), a REIT can go into default. A default may mean liquidation, where the REIT’s assets will be sold off. In such a scenario, its creditors (lenders) will be repaid before the unitholders/investors. This risk is somewhat reduced by regulations, which currently cap the maximum amount of a REIT’s borrowings at 50% of its total asset value.

Risk #5: Concentration Risk

Somewhat related to business risk, concentration risk arises when a REIT only has a few properties in its portfolio. This means that if the business of any one property falters, the REIT as a whole will be more exposed.

Risk #6: Interest Rate Risk

Interest rate risk is something most people are unaware of. But it plays a big role in any kind of income investing (i.e. when investors expect to receive regular cashflows/dividends from their investments). This is because interest rates effect how much you can get from truly safe investments like fixed deposits (FDs).

Consider this example. If FD rates were 3% and a REIT’s dividend yield was also 3%, why would you opt for the riskier REIT? This means the higher interest rates are, the higher the dividend yield on a REIT must be to compensate. And since dividend yield is calculated by the formula Dividends/Price, the lower the price the higher the dividend yield. This means that higher interest rates can put downward pressure on a REIT’s prices.

However, the link between REIT prices and interest rates are far from definite. Unlike bonds, the dividends REITs pay out are not fixed. If dividends increase, then dividend yields can match higher interest rates without any drop in prices. This is more likely to be the case when interest rates are rising because of a prospering economy.

Finally, it is also important to understand how interest rates affect the business of the REIT itself. Rising interest rates mean higher interest payments the REITs must pay on their borrowings. This can lead to increased business and refinancing risk.