Navigating real estate investment on a global basis

By Christopher M. Wright

Real estate investment is gaining momentum around the world because of the widespread adoption of the REIT in more than 20 countries. New global funds are popping up, offering an expanding range of investment opportunities.

Investors can now choose in Asia, Europe or the United States. Offerings are available in developed countries or in emerging markets. Managers can choose among property fundamentals or stock valuations in several markets in passive indexing or active stock selection strategies.

To learn how seasoned global portfolio managers are navigating this new world of real estate investment opportunities, Portfolio sat down with Martin Cohen, co-chairman and co-CEO at Cohen & Steers; Nancy Holland, global head of property at ABN AMRO Asset Management; Jonathan Kern, global CIO at GE Real Estate; Kelly Rush, director and portfolio manager at Principal Global Investors; Amy Schioldager,managing director, global index and markets group at Barclays Global Investors;and Patrick Sumner, head of property equities in the London office of Henderson Global Investors.

Portfolio: How is international real estate investing different today from five years ago?

Kelly Rush: Accelerating globalization is the big force at play. Companies operating on a global scale are demanding modern functional real estate, and developers are satisfying these real estate needs. Investors are prepared to provide the capital without regard to borders.

Patrick Sumner: Adding to that, real estate equities are gradually becoming a global market, just like other listed assets. There are dozens of global funds, the vast majority of which have appeared in the last five years, and companies can raise money on three continents. The drivers include: abundant liquidity, strong property markets, REIT legislation in key markets, more fund managers in the sector, and more research and information.

Amy Schioldager: Additionally, institutional investors, such as pension plans, endowments and foundations, have adopted a global approach to equity investing. Today, 95 percent of public pension plans have exposure to developed markets. Global real estate investing will become a core asset class within the portfolio of institutional investors over time.

Martin Cohen: However, looking specifically at Europe, the 2003 passage of Sociétés d’Investissements Immobiliers Cotées (SIIC) legislation in France was a very important event, because the success of French REITs has served as a good model for the rest of continental Europe. It paved the way for German, Italian and U.K. REITs. While the circumstances in these markets are very different, we believe that the success of the French REIT market will be duplicated in these other European markets.

Portfolio: What are the most exciting regions or investment themes in international real estate going forward?

Jonathan Kern: The most prominent feature of global real estate is the abundance of pricing and growth opportunities compared to the United States. Many economies abroad are growing faster than the United States. Many markets have a rapidly growing middle class that is generating demand for certain kinds of real estate, especially retail. You also see less supply in many of these places, such as Poland and the Czech Republic.

Certain large, growing cities in China have a tremendous scarcity of Class-A office space and quality housing. Supply is also limited in Korea, where vacancy in Seoul’s central business district is less than 2 percent and there is a high demand for first-class office space.

Nancy Holland: However, regionally, we expect Europe to outperform in 2007. Valuations remain attractive, especially compared with multiples in Asia and the United States. European office markets are moving into the recovery stage of their current cycle. As occupier demand continues to increase and supply remains constrained, we expect rental growth to return to a number of European markets.

Sumner: On the other side of the pendulum, we favor India right now. Even though there have been some initial difficulties, it is a more professional market than many others. We also like South Africa, where a sophisticated financial infrastructure accompanies emerging market opportunities. However, the most exciting area is development in Eastern and Central Europe, where the long-term prospects in several markets and sectors are very good.

Schioldager: As indexers, we strongly believe that exposure to all regions will eventually prove to achieve superior returns, especially when considering management fees. However, Europe is an interesting area for the following reasons: more than 70 percent of U.K. real estate companies converted to REITs. Germany is by far Europe’s largest real estate market. The potential is expected to be considerable. The Initiative Finanzstandort Deutschland (IFD), an action group for the German financial sector, predicts a market capitalization potential for the German REIT by 2010 of up to EUR 120 billion ($165 billion).

Portfolio: How do REITs stack up as global real estate investments versus listed REOCs, direct real estate and other investment vehicles?

Cohen: REITs are very competitive with all other vehicles in which one can invest in real estate. With respect to direct real estate and other investment vehicles, the liquidity of the public market makes listed companies very attractive. Additionally, the active management of listed real estate companies enables these companies to enjoy returns that are greater than any individual underlying property.

Sumner: However, it is important not to regard REITs as different from tax-paying property companies, or less risky. Some REITs may have lower leverage or less exposure to development, but at times they will tend to underperform. A global fund should be able to vary the proportions in REITs or developers according to market conditions.

Property equities are the only way to achieve global diversification. One advantage of property equities over direct property is liquidity. There are unrecognized risks in matching an unlimited liquidity promise to an asset class that is extremely illiquid.

Schioldager: I agree with Patrick, and I’d like to underline the main differences between REITs and direct real estate. In our view, publicly traded real estate has the following advantages: ease of investment, with investment vehicles exhibiting high liquidity to allow an investor to contribute a $100 million slice within one trading day; diversification, with investors receiving diversification across countries; and companies with indexed assets having a low turnover rate that are, therefore, ideal for securities lending.

Holland: I’d like to add that transaction and management costs for direct real estate, unlisted property or other vehicles with a capital commitment are considerably more expensive than with listed property, which offers an easier and more efficient way to gain access to the investment characteristics of property. Diversification—either geographically, by property type or by tenant—is much easier to obtain through publicly traded property securities.

Portfolio: What allocations for domestic and foreign real estate are you recommending for U.S.-based client portfolios and why?

Schioldager: The typical large pension plan has a 3 percent to 5 percent allocation to domestic real estate. Since the market cap of U.S. REITs is approximately 50 percent of the global listed real estate markets, an additional starting allocation of 3 percent to 5 percent of global real estate seems reasonable.

Holland: Our client base is global in nature, so there isn’t a standard answer. Studies by Ibbotson Associates show that an optimal real-estate allocation is between 10 percent and 25 percent of an investment portfolio. There has been a trend toward global real estate exposure in the last two to three years. We view this as a healthy evolution of the market and a reflection of pricing in local markets and the evolution of REIT structures globally.

Portfolio: International investing carries special risk such as currency risk, political risk and increased volatility. What special techniques do you use to manage risk in your international real estate portfolios? Specifically, what are you advising clients about investment time horizons?

Sumner: We advise clients to apply the same time horizon to property equities as they would to direct property investment, medium to long-term. We do not take currency risk into account. There is no magic formula. It comes down to experience and judgment.

Kern: When advising clients, our risk management approach is the same in every country. We apply centralized risk management disciplines to each investment driven by local market dynamics. Liquidity may be global, but real estate is still local. We have people on the ground in all major global markets who understand their markets’ unique business dynamics, laws and regulations.

Portfolio: What, if any, new developments are you expecting in the way business is done?

Cohen: There are certain asset types that lend themselves to a multinational scope, but not in residential and office sectors. However, with respect to industrial and distribution facilities, companies like ProLogis, Inc. (NYSE: PLD) and AMB Property Corporation (NYSE: AMB) have proven that a multinational platform is very beneficial in attracting clients, building properties in different markets and expanding the company’s opportunity set.

Schioldager: However, it is important to remember that globalization will not bypass real estate. In the future, we will increasingly see companies with cross-border investments.

Sumner: It takes a lot of organization to operate multi-nationally, as companies in every sector have discovered. Westfield operates in a significant way in only three countries—Australia, the U.S., and the U.K. Hardly global. It is more of a challenge to operate in 14 European countries, as is the case with the combined Unibail-Rodamco, the second-biggest property company in the world after Westfield.

Portfolio: What do you expect global real estate investing to look like five years from now?

Holland: Global property markets are likely to continue to be affected by positive structural forces, such as the introduction and evolution of REIT structures, the rebalancing of investment portfolios towards property and the increasing consolidation in the listed property market.

Sumner: Additionally, the real estate equities sector is likely to grow in terms of market capitalization, but perhaps not in the number of stocks. Expect consolidation. Returns will not compare with the last four years and are likely to be in the low- to mid-teens. Oversupply is the major curse, not rising interest rates. Stability in terms of supply and demand is key.

Kern: However, I think that worldwide, we will see a relatively benign macroeconomic environment, which bodes well for the continuing globalization of commercial real estate. With theirsolid fundamentals and limited supply, strong markets, such as Japan, Mexico, Korea and Central Europe, should perform well, and other new markets will emerge. We also anticipate a continuing shift to a new dynamic in real estate investing.

Schioldager: I agree with Jonathan, that current global real estate investments are focused on developed markets. However, I’d like to add that emerging markets are having an increase in importance and account for more than 20 percent of the world’s annual economic output. The second wave of global real estate investing will encompass investments in these emerging markets. The maturing of countries like Taiwan, Korea, and China, and the relaxation of restrictions on foreign ownership should present real estate investors with tremendous opportunities in the future.

Christopher M. Wright is a regular contributor to Portfolio.