Investing in commercial real estate abroad is becoming easier.
Impressed with its strong returns and looking to diversify client portfolios, more advisors undoubtedly have added U.S. commercial real estate to their investment mix. Add to that all the attention being given to growing business opportunities in foreign markets, and an advisor may wonder if it's time to go global with real estate.
Indeed, international commercial real estate may be another way to diversity portfolios, and it certainly has provided handsome returns. If the dollar continues to fall, as some analysts believe, that could contribute to a further rise in the value of foreign real estate. According to the National Association of Real Estate Investment Trusts, in 2004 the EPRA/NAREIT Global Real Estate Total Return Index rose almost 38%. Over the last five years, its compound annual total return was 16.8%. (EPRA is the acronym for the European Public Real Estate Association.) The 2004 total return for the global index, not including North American companies, was 43.4% (52.7% for Europe, 36.8% for Asia).
Those numbers compare with a 30.4% return in 2004 for the NAREIT Composite Index of publicly traded U.S. REITs. Over the last five years, the U.S. index has produced a compound annual total return of 22.5%.
"Look back in time and you'll discover that real estate stocks have outperformed the S&P 500, the Dow Jones Industrial Average and the Nasdaq on a compound annual total return basis over the past 30 years," says NAREIT Senior Vice President of Research and Investment Affairs Michael R. Grupe. "Any investment sector may outperform or underperform other sectors over short periods of a few years, but REITs' long-term record of high total returns, reliable stock dividends and low correlation create critical diversification benefits that make REIT stocks a necessary element of any balanced portfolio."
The choices for putting money into commercial real estate abroad are more limited than in the United States, but new options should be available in the coming years as countries continue to create REIT-like structures. REITs will broaden the shareholder base in global real estate and make it easier for smaller players to invest, observers say.
Before looking at the current options for investing, let's get a sense of the global commercial real estate market. A December 2004 report by UBS Investment Research estimates $5.95 trillion in commercial real estate is held worldwide in both the private and public markets for investment purposes (See Table 1). The report estimates that the United States has 42% of that total, but only 12% of U.S. commercial real estate is securitized.
Although the United States has by far the largest commercial real estate market in the world, most properties are owned directly or by private companies, notes NAREIT's Grupe. NAREIT estimates REITS own only about 15% of U.S. commercial properties, and Grupe expects that percentage to grow slowly but steadily to between 30% and 50% over the next 15 years.
Although commercial property markets are much smaller in other countries, some are more securitized than in the United States. For example, UBS estimates the United Kingdom has 8% of the global investable real estate universe, but 17% of its market is securitized. Australia has only 2% of the total, but 52% of its market is securitized.
Scott Crowe, director and global real estate strategist for UBS Investment Research, says the number of publicly traded, or listed, real estate firms worldwide is growing and their market capitalization should double to about $1 trillion by the end of the decade. When looking at the listed real estate universe, Crowe says, companies fall into two categories: developers and investors.
Developers, firms that create real estate product and sell it, account for about 16% of total market capitalization, the UBS report says. One of the largest companies in this category is Hong Kong's Sun Hung Kai P., a residential developer with a market cap in U.S. dollars of more than $24 billion in December. Others include Singapore-based City Developments Ltd., an international property and hotel conglomerate operating in 21 countries, and Mitsubishi Estate Co., one of Japan's largest real estate firms.
Investors, companies that own property and get at least 70% of income from rent, represent about 84% of listed real estate firms. About three-quarters of investor companies are REITs or similar structures, with others being listed property companies, Crowe says. A large, well-known example of an investor firm is Australian-based Westfield Group, a limited property trust (Australia's version of a REIT) and one of the largest retail property companies in the world with investment interests in 127 shopping centers in four countries. Others include Rotterdam-based Rodamco Europe, the largest listed property investment and management company in the retail sector in Europe; London-based Land Securities Group PLC, the United Kingdom's largest listed property company; and U.S.-based Equity Office Properties, the country's largest publicly traded office building owner and manager.
Buying into U.S. REITs like Equity Office Properties is relatively easy for U.S. investors, but what if your client wants global real estate exposure in publicly traded securities? Investors may be able to buy individual shares of overseas companies on a foreign exchange through their broker, but trading costs can be relatively high and making good choices can be challenging if you aren't familiar with various real estate markets. Another option for high-net-worth individuals might be to include some of these stocks in a managed account. For example, ING Clarion, a subsidiary of ING Group, offers real estate separate account strategies that include a global real estate portfolio that invests in the United States, Europe and Asia.
Yet another choice would be to invest in U.S. REITs that have overseas investments. Grupe says he's seeing more U.S. REITs expand internationally, particularly in the industrial and retail sectors. AMB Property Corp., based in San Francisco, and Prologis, headquartered in Aurora, Colo., are examples of U.S. REITS that have taken significant steps in this direction, he notes. Both own primarily industrial space in this country and abroad. AMB owns 1,106 buildings, including distribution facilities in North America, Europe and Asia that are designed to speed its customers' goods to market in locations near airports, seaports and major transportation centers. Prologis has more than 1,970 facilities in 70 markets throughout North America, Europe and Asia.
But if foreign real estate exposure is strictly what your clients are after, probably the least complicated and more effective way to invest would be to buy shares of a global real estate mutual fund. Morningstar does not break out the category and only a handful of these specialized funds exist now, but more money managers have been getting involved over the last few years or are looking to do so. In addition to its separate account strategies, for example, in November 2001 ING introduced the ING Global Real Estate Fund. Its three-year annualized return as of February 3 was 24.31% and its one-year return was 23.47%.
A newer entrant to the field is Fidelity Investments. In September the Boston-based firm announced the launch of the Fidelity International Real Estate Fund to invest primarily in non-U.S. securities of companies in the real estate industry. "We have been looking at this type of fund for many years. We finally felt there were enough companies and market cap from an investment standpoint to have a large enough universe," says Steven Buller, the fund's manager.
Although this is the first Fidelity fund to focus specifically on international real estate investing, the firm for decades has included companies with foreign real estate investments in its diversified equity funds. Buller says the new fund includes publicly listed REITs and other types of property companies. He is focusing more on picking solid companies, with a secondary look at whether to overweight or underweight particular countries.
"It's a niche product. It's not for everyone," Buller adds. "It's combining two areas: Most investors are underweight in real estate and may be slightly underweight in international investments." He says Fidelity is marketing the fund toward higher-net-worth individuals who may have REITS and international holdings, but who also are looking for alternative or specialized investments.
From its inception on September 8 through December 31, the Fidelity International Real Estate Fund (FIREX) posted a cumulative total return of 18.61%, and as of January 4, the fund had net assets of $122.88 million. As of November 30, the countries in which the fund had the most assets invested included United Kingdom, 23.6%; Hong Kong, 17.3%; Australia, 12.9%; Japan, 11.5%; and the United States, 8.2%.
New York-based Cohen & Steers, an income-oriented portfolio management firm that says it is the nation's largest U.S. REIT manager, is becoming more involved in international real estate as well. The company filed last year with the Securities and Exchange Commission to launch closed-end and open-end global real estate funds for U.S. investors, says John McCombe, executive vice president and head of the firm's sales and marketing. Although the company doesn't have a launch date for the funds, McCombe says he expects it will be this year.
According to the firm's November 23 SEC filing for the open-ended Cohen & Steers Global Realty Fund, Cohen & Steers Capital Management Inc. will be the fund's investment advisor and Houlihan Rovers S.A. will be the subadvisor. On December 14, Cohen & Steers announced it closed on the acquisition of 50% of the capital stock of Houlihan Rovers, a Belgium-based global real estate securities asset manager with approximately $500 million under management. At the time, Robert Steers, co-chairman and co-chief executive officer, commented the investment would allow the firm to offer its clients more choices as REIT-like vehicles are adopted around the world.
One of the oldest real estate funds around (U.S. or international) is Alpine International Real Estate Equity Fund, started in 1989. According to Morningstar, the fund returned 36.1% last year. On an annualized basis, its three-year return was 30.94%, its five-year return was 19.52% (both as of February 3) and its ten-year return was 9.68% (as of December 31).
"It's relatively recently that international real estate investing has taken hold, in part because the performance of real estate over the last five years has been quite good, not just through funds or REITs but through direct investment as well," notes Samuel A. Lieber, president of Alpine Mutual Funds and portfolio manager of its U.S. and international real estate funds.
Lieber has found Europe attractive, partly because of currency issues and also because more REIT-like structures are available. France is particularly attractive, and he also thinks Spain and the Scandinavian countries offer opportunities. "Everything is being globalized in the world, and real estate is one of the next frontiers. Investors here are looking for greener pastures abroad," Lieber says.
In the next several years, choices should increase for individuals interested in investing in international real estate as more countries adopt REIT-like structures and more firms create mutual funds that invest in them. According to NAREIT, at least 20 countries have created or moved toward creating structures similar to U.S. REITs, first introduced in 1960.
Like the United States, Australia has long offered REIT-type investments. Other countries with them include the Netherlands, Canada, Belgium, Singapore, Japan, France and Hong Kong. The United Kingdom also is planning to introduce REITs.
Although similar to U.S. REITs, which must distribute at least 90% of taxable income to shareholders annually through dividends, the foreign versions often have somewhat different investment restrictions, tax requirements and payouts. Some are more attractive than others. For example, Andrew A. Davis and Chandler Spears, portfolio managers of the New York-based Davis Real Estate Fund, are among those who have spent a lot of time looking at the J-REIT, Japan's vehicle, and they don't like its externally advised and managed structure. Outside managers are paid to manage assets and they get paid to buy more properties, which creates conflicts of interest, they say. France, in contrast, has a very good REIT structure, they add. The U.K. is where they've focused most internationally, investing in listed property companies.
Carol Broad, director of real estate research for Tacoma, Wash.-based Russell Investment Group, also is carefully watching trends in property securities overseas. She expects more offerings in parts of Asia and Europe over the next several years. In areas that already have REIT legislation, a lot of initial public offerings are queuing up to come into those markets, she adds.
"Most of the market today is in the U.S., and there are limited advantages to going overseas, but as those markets become more developed, they will become more interesting opportunities," she says.