As REITs go global, are investors ready to go with them?

By Steve Bergsman

Either prepare for globalization or be left behind. That appears to be the thinking of some of the top investment and investment banking organizations as they approach the expanding world of real estate investment trusts. For decades, only a handful of countries such as the United States, Australia, Canada and the Netherlands offered a publicly traded real estate investment vehicle (akin to U.S. REITs), but over the past few years REITs have been introduced, or are being considered for introduction, in Japan, Singapore, Hong Kong, South Korea, Malaysia, Costa Rica, France, the United Kingdom, Germany, Belgium and Turkey, among others.

This will create worldwide opportunities for investors, which is why Morgan Stanley Real Estate announced in March 2005 that it will be expanding its investing business in Germany, one of the European countries on the cusp of introducing a REIT structure. Morgan Stanley Real Estate already boasts a global presence in 12 countries and will be creating a regulated real estate investment management company that will offer investors access to core real estate investment products.

Also this year, Los Angeles-based CB Richard Ellis Investors LLC introduced its new unit, CBRE Global Real Estate Securities, an investment program providing dedicated global securities investment and management services. When announcing the program, the company cited the tripling of the global real estate securities market, "with a dozen major countries offering REIT-style vehicles, which promises even greater growth over the next 10 years."

Meanwhile, James Keagy, managing director at Barclays Global Investors in San Francisco, says the company might be offering a "global REIT product" sometime before the end of 2005.

The common theme among companies that organize funds for the purpose of investing in publicly traded real estate securities is that globalization portends unlimited movement of capital among a wider range of geographic regions. Although, everyone warns, large-scale, global REIT investing will not happen overnight. "We are five years away from the majority of REIT investors realizing you need to be invested globally," Keagy observes.

Picking Up the Pace

Since 1990, the free float market capitalization of global real estate securities has nearly quadrupled from about $150 billion to $505 billion at the end of 2004, reports CBRE. In recent years, these numbers have been boosted by the rapid growth of the Singapore REIT market to approximately $2.5 billion and the very successful Japanese REIT (J-REIT) market, which has experienced the creation of 16 REITs, reports Steve Carroll, co-chief investment officer of CBRE's Global Securities Team, based in Baltimore. The global market would receive another significant boost if the derailed $3 billion initial public offering of Hong Kong's Link REIT (the largest planned IPO in REIT history) gets back on track.

"We are entering a new phase in 'REITdom' in that more and more investors are going to think about REITs from a global perspective because the model is becoming increasingly accepted worldwide," Steve Carroll says. "The investment universe is broader and opportunity is greater."

"We are entering a new phase in 'REITdom' in that more and more investors are going to think about REITs from a global perspective because the model is becoming increasingly accepted worldwide," Carroll says. "The investment universe is broader and opportunity is greater."

As of Sept. 1, 2005, the global REIT "investable universe," as measured by the free float market cap of the FTSE EPRA/NAREIT Global Real Estate Index, topped $587 billion.

"The investable universe is growing so dramatically, but we are only now at the inflection point in terms of the growth path for global REITs," Carroll says.

ING Groep NV is one of a small number of companies with a global fund already in place.

"While the United States is the dominant piece of the global REIT pie, it's only about 70 percent of the universe in term of a REIT investment strategy," notes Steve Burton, a senior director with ING Clarion Real Estate Securities, a subsidiary of ING Groep NV. "There are other slices out there and some of them are growing rapidly. For example, the aggregate market cap of J-REITs is now around $20 billion."

According to FTSE EPRA/NAREIT Global Real Estate Index data as of Sept. 1, 2005, the U.S. accounted for 50 percent of total market capitalization of global real estate companies, while Australia accounted for 11 percent; the U.K., 9 percent; Continental Europe, 10 percent; Japan, 8 percent; and Hong Kong, 7 percent, with a small basket of other countries contributing the remainder.

In one respect, says Burton, the U.S. is not the most advanced market in terms of securitizing real estate. In the U.S., about 15 percent to 20 percent of institutional quality property has been securitized in the form of REITs, but in Australia that number jumps to more than 50 percent.

Cohen & Steers Inc. offers both an "international" and "worldwide" REIT fund. "We are spending a lot of time on global (real estate) securities," according to James Corl, chief investment officer at the New York-based REIT management and investment banking firm. "It is a big deal for us."

In May 2005, the Cohen & Steers Worldwide Realty Income Fund Inc. was priced for a total offering of $153 million. The fund will invest primarily in a portfolio of global real estate equity securities. The older Cohen & Steers International Realty Fund proclaims that under normal market conditions it invests at least 80 percent of its total assets in a portfolio of non-U.S. real estate equity securities. (Real estate securities include common stocks, preferred stocks and other equity securities issued by real estate companies, including REITs.)

Corl cautions progress has been slow. "The amount of dollars in real estate funds dedicated toward real estate securities on a global basis is only about $2 billion," he adds. "You have ING with a global fund, Cohen & Steers with a global fund and a couple of mutual funds. There could be arbitrage between Australia, the U.K., France and the U.S. seeking best values across the entire global spectrum, but it is a very small pool of capital."

Corl does expect that to change in the near future. The globalization of REITs is a "fantastic" phenomenon, Corl exclaims. "It is going to stimulate more interest in real estate in general. Real estate is under-weighted in just about everyone's portfolio, including both domestic and international investors, so the creation of REITs in other countries will draw investment dollars from the U.S. as well as from other countries. It is going to open up the investment class to investors that have never really been able to tap into REIT investments before. More demand will be created everywhere."

Plus or Minus for the U.S.

There is, perhaps, a negative to the globalization of the REIT market: the new international REITs could draw away investment capital that would normally be allocated to U.S. REITs. While it is a possibility, most investment bankers involved in the REIT industry don't believe that will be the case. When asked if new global REIT markets will drain capital away from the U.S. REIT market, the unanimous response has been the opposite. Every time another country passes REIT legislation it helps create a bigger investor base for REITs worldwide.

"The rise of the J-REIT absolutely has led to a heightening of interest in real estate of all types and a heightening of interest in REITs. This, in turn, has led to a very steady and strong fund flow to U.S. REITs out of Japan," Jacques Gordon says.

The sentiment on global REIT expansion is succinctly summed up by ING's Burton when he says, "the more REIT-type structures that are created and adopted around the world, the more it creates an awareness of this investment vehicle."

This starts people's creative processes flowing, Burton adds, "money managers around the world start scratching their heads and thinking, 'maybe we could develop a fund or product that invests in REITs globally.'" When local investors in their own markets become acquainted with REITs, they see the greater liquidity, better transparency, improved disclosure, and higher quality research and analyst coverage, says Christina Chiu, an associate in the global real estate securities group of Morgan Stanley in New York.

"After they really get comfortable with real estate securities and know what the investments are all about, they'll take the next step, which is to diversify outside their local market. And the interesting thing is, when they look to diversify, the first place they go is to the U.S. It is an easy market to get into, large and well-established, liquid, and many research analysts cover the different companies."

To which Chiu concludes, "international investors have been a little quicker to go global. U.S. investors are still more in the decision-making stage."

Heitman LLC, a Chicago-based real estate investment management and banking company, also runs offices in Europe and Japan. It serves a global client base making investments in commercial real estate directly and in REITs in the U.S. and Europe.

"We represent Japanese retail and European institutional clients coming into the U.S. markets, and we see good flows of capital coming from foreign countries into the U.S. REIT market," says Timothy Pire, Heitman's managing director of its real estate securities group.

At first, Pire cautions, a certain amount of capital intended for REITs will stay at home. A Japanese investor will initially invest in J-REITs. Once the local investor gets used to the structure, then the next step will be to seek out an international REIT.

Investment managers report there has been no extraordinary movement of cash flow away from U.S. REITs since the introduction of more REIT structures worldwide.

"Capital flow into U.S. real estate markets has accelerated over the last couple of years and now is at a higher level than even in the late 1980s when the Japanese were active in North America," reports Hugh Macdonnell, an executive director of Morgan Stanley.

Jacques Gordon, global strategist with LaSalle Investment Management in Chicago, asserts, "I have seen the international REIT market evolve over the last three to four years and have seen no slowdown in interest in U.S. REITs."

Gordon uses the J-REIT phenomenon as an example. "The rise of the J-REIT absolutely has led to a heightening of interest in real estate of all types and a heightening of interest in REITs. This, in turn, has led to a very steady and strong fund flow to U.S. REITs out of Japan," Gordon says. LaSalle has even formed an alliance with a Japanese asset manager to tap into this business.

Another Chicago-based company, Macquarie Capital Partners LLC, has had a similar experience to that of LaSalle—except that Macquarie doesn't manage REIT investments. It holds to a quiet little niche built around accumulating private equity as a capital source for REITs. To raise money for acquisitions, a REIT can tap into the private capital pool raised by Macquarie instead of selling shares on the stock market or doing joint ventures. The company runs an office in London to do the same thing for European property companies.

Since it raises capital internationally, Macquarie holds an interesting perch above the flows of international money to real estate. "There is a lot of activity that is going on in terms of offshore investors," says Donald Suter, Macquarie's managing principal and chief executive officer. "Whether the capital is in Asia and going to Australia, or Australia to the U.S. or U.S. to Europe, the cross-border deal flow of capital going into real estate has to increase."

Marja Lutsep, who worked with real estate companies while at Ernst & Young, recently became the director of the graduate tax program at New York University's School of Law. One trend that might develop, she says, is for U.S. REITs to invest in foreign assets through a foreign REIT in order to lower their tax burden.

"I expect more activity in U.S. REITs investing in foreign REITs," Lutsep says.

New Way to Diversify

With the growth of REIT-type investments in other countries, some investment managers believe the next step will be for REIT investors, in particular, and REIT funds, in general, to create portfolio diversification internationally in addition to the traditional sector plays. "To diversify a stock portfolio investors look to global securities," says Heitman's Pire. "Now, investors have come to the realization, 'why can't I do that for real estate?' People are going to look at their REIT holdings and start to diversify globally."

Jeremy Anagnos, co-chief investment officer of CBRE Global Real Estate Securities in London, concurs. "You have a bigger investor universe with a potential for higher returns because international REIT markets don't move in tandem. Over-weighting certain sub-regions relative to others can improve your overall returns and, surprisingly, lower your volatility."

Tax Rate Chart To view a detailed table listing the U.S. withholding tax rates on ordinary REIT dividends to non-U.S. investors, visit www.realestateportfolio.com.