Let's begin this lecture with me asking you this. What exactly are investment risks? How do we go about interpreting such a concept? Well, a practical way of interpreting risks is simply the chance that you won't receive back the amount that you have invested. You see, when it comes to risks, here's a reality check. All investments carry some degree of risk, whether it is stocks, bonds, or exchange traded funds, all of them can lose their value.
If market conditions turned sour enough, even our own reads come with their own unique risks. Let's do a quick recap. Throughout the step A, B and C we have gained a better understanding of how each type of reworks learns how to filter them, and of course learns how to determine their worth. As for the last step, step D which is one of the most crucial step to take in order to become a full fledged mastery investor. Step D is all about knowing the risks associated with real investments and learning how to manage them effectively. This is an important chapter, because the majority of retail investors do not monitor their portfolio, let alone understand what they have invested in.
Not surprisingly, many of this so called hands off investors usually do not do well in the long run. As such, this is one path you would want to avoid following. Therefore, let me guide you to the right direction by identifying for you the three important risks you need to take note of when investing in reeds. Number one, changing demand and supply trends. Sometimes a read may suddenly become aggressive in buying up overseas properties. This sudden change in strategy maybe due to keeping up with supply trends.
Take for instance, the industrial rates in Singapore have been experiencing falling occupancy and rental rates due to the increasing number of industrial buildings popping up in the logistic industry. The reason for this oversupply is because the government intends to keep the overall cost of business conducive and competitive. Fortunately, many of these industrial rates have foreseen this threat and have taken measures such as divesting their local properties earlier on, while concurrently buying up new properties in Australia or China. Now, imagine if you industrial rate investor, both the management and you are not aware of these demand and supply changes, what do you think will happen? The dividends you receive will start to dwindle and your read unit price will start to fall while you struggled to find an answer for the poor investment performance and demand an answer from the management, the management will just blame it on the weak economy, a reactive scenario that plays out many times for investors who are oblivious to what's going on with their read investments.
Number two, conflict of interest. misaligned interest can come from two sources, one from the read sponsor, and the other from the management performance fees. Let's talk about the read sponsor first. Recall that many listed reads have sponsors as they're backing. And many of these sponsors are usually a big property developers, the business model of property developers is to buy land or rent the buildings on it and then sell them off to others. But did you know that in some countries, if a developer isn't able to sell the buildings within a certain period, they will be penalized?
Heavily. This is the government's way of ensuring property speculations are kept low. As such, there is strong incentive for developers to offload their not so popular buildings to another willing party. And sometimes that party could be a read it regardless of whether the reader is willing or not, since the property developer is also the biggest shareholder, hence the conflict of interest. Now, for the managers performance fees, you should be concerned if the fees are pegged heavily to the gross revenue or its portfolio size. Why do you think this is so?
Well, having such policies will encourage the management to acquire more properties to grow the reach revenue in order to earn a higher fee. As a result, pay less attention to the properties insight or actually yield a creative This is especially so for countries with no enforced gearing limits such as America. turning a blind eye on how the managers are being compensated will result in you receiving lesser and lesser yields while read managers enjoy larger and faster bonuses over the years. Number three, interest rate risk. Because of the way reads are structured, conserving sufficient cash was never a luxury that reads could afford. As such summary borrow heavily and those with alarmingly high debt amounts on their balance sheets are vulnerable to any increase in interest rate.
How this works is this. In the event that interest rate rises, it causes a hike in the reeds interest expenses, in turn affecting the amount of distributable income, meaning lesser dividends for shareholders. This will cause the unit price of the rate to fall as a result divest and seek out better investment opportunities. While keeping all these in mind. We got to know how to manage these risks in the next lecture. So see you there.