Investors Seeking Higher Returns and Broader Diversification Are Turning to a Global Portfolio

By Steve Bergsman

As more European and Asian countries have passed legislation allow-ing the formation of publicly traded, tax-transparent real estate companies, REIT investors have increasingly turned their attention to global real estate investment opportunities. Sensing that American investors have finally grown comfortable with allocating part of their portfolio to foreign REITs, investment management companies also have begun rolling out investment funds that tap into the emerging global listed real estate market.

The New York investment management subsidiary of General Motors Asset Management Corp. (GMAM) boasts $160 billion in assets for both affiliated and unaffiliated clients, and of that, some 6 percent resides in real estate of one sort or another, including REITs. While about 15 percent of its overall real estate assets go into global opportunities, GMAM has never made the global leap with its REIT—until now.

“We are in the process of expanding our public securities portfolio to include non-U.S. REITs,” notes Jamie Behar, the company’s managing director of real estate and alternative investments. She adds as a general matter, “our international real estate exposure both in private and public markets will grow over time.”

GMAM has been investing in REITs as a pension fund manager since 1992, and its REIT portfolio management is almost totally in-house. GMAM has established a strong comfort level with REITs, based on this long, hands-on experience. The rationale for its current decision to expand the scope of its program to include global REITs: there is an increasing maturation and transparency of public real estate markets worldwide, Behar says, and GMAM expects to achieve more efficient diversification and higher returns with a global portfolio than with just a portfolio concentrated only in the United States.

GMAM’s interest in global REITs is part ofa broader shift in strategic allocations by U.S.institutional investors that started 18 months ago.

Asset managers, especially those with international ties and a history of promoting cross-border, listed real estate investment strategies, are finding more investors heeding their words instead of politely ignoring their suggestion, as had been the case in the past.

European Investors Inc. began offering its U.S. clients the opportunity to invest globally back in 2000, but there was “only a trickle of interest,” says James Rehlaender, managing director of the asset management company. “The big demand has only come in the last six to 12 months.”

It’s the same story at ING Clarion, which has been offering U.S. investors the opportunity to go global through internationally focused open- and closed-end funds since the turn of the millennium, but found little interest until recently.

“We have been stating the global investment thesis for almost five years now, if not longer,” says Steven Burton, a managing director at ING Clarion Real Estate Securities LP. “Beginning about two or three years ago, investors started to nod their heads and show interest—but, as an execution strategy, there was no traction until about 2004.”

Then in 2005, the business of investing in global real estate stocks took a quantum leap forward at ING Clarion, Burton says.

“I don’t know if it was awareness building, a greater sense that U.S. real estate was becoming more fully priced, or maybe part of a broader trend of investors looking internationally for all kinds of asset classes, not just property stocks,” Burton says.

Global Markets Evolve

The global listed commercial real estate market as measured by the FTSE EPRA/NAREIT Global Real Estate Index Series, is more than $700 billion and includes more than 300 companies, Burton says. North America makes up slightly less than half that total, “so there is a big, diverse universe of real estate stocks out there.”

Dividing up the globe, one would find roughly half of the total in North America, 30 percent in Asia-Pacific and 20 percent in Europe, with the latter split 50-50 between the United Kingdom and Continental Europe, Burton says.

However, if one just looks at REITs on a worldwide basis, the market is somewhat smaller, at around $470 billion, says Steve Carroll, managing director and chief investment officer of CB Richard Ellis Investors’ Global Real Estate Securities.

A September 2005 study by Morgan Stanley Investment Management caught the industry in mid-growth mode. Morgan Stanley’s list showed 152 REITs in the United States (value $300.6 billion of equity market cap); 25 REITs in Canada (value $17.2 billion); 24 listed property trusts in Australia (value $66.1 billion); 23 listed property companies—J-REITs—in Japan (value $22.9) billion; seven listed property companies—S-REITs—in Singapore (value $6.5 billion); seven listed property companies–FBIs–in the Netherlands (value $17.5 billion); 10 listed property companies—SICAFIs—in Belgium (value $4.8 billion); and 10 listed property companies—SIICs—in France (value $17.1 billion).

However, six months later in March 2006, those numbers, especially in Asia, looked a lot different. REITs in Japan, commonly known as J-REITs, started in 2001 and have reached 32 in number and are valued at $30 billion, according to Burton. “In a given two-month period, there seemed to have been at least one J-REIT initial public offering over the past year,” Burton says.

The newest market, Hong Kong, already boasts four REITs and the IPO pipeline shows at least 10 companies ready to go public over the next 18 months. “There are already at least 20 real estate companies in Hong Kong, not including the REITs,” Carroll says.

Macquarie Bank Ltd., based in Sydney, manages geographical sector real estate funds representing four different countries: Australia, Korea, New Zealand and Singapore. The size of those listings totals approximately $20 billion.

“We have seen, on average, in the Australian market, a substantial increase in the number of investors coming from offshore, particularly from the U.S., such that, six to nine months ago, we might have had just 2 percent of registrations filed by foreign investors but are now at 10 percent to 15 percent,” says Mark Baillie, head of real estate North America and Europe for Macquarie Real Estate Inc. (NYSE: MPG).

The real money flowing into global REITs these days is coming from places like Australia, Canada, parts of Europe and Japan. “The United States is on the cusp,” Carroll says.

On the private market side, U.S. investors have been investing offshore since opportunity funds were created in the mid-1990s. “Now on the public market side, all the major consultants and major domestic pension plans have begun gearing up to invest globally,” Carroll adds.

James Keagy, managing director at Barclays Global Investors, adds that a lot of the growth in the real estate industry is happening overseas. “A smart way for investors to capitalize on that growth is through publicly traded real estate securities around the world,” he says.

“The securitized real estate markets around the world are getting bigger and represent an important opportunity,” he says. “Investors just cannot sit on the sidelines any longer.”

Venturing Out

Baillie, who is also chairman of the Association of Foreign Investors in Real Estate (AFIRE), reports that the company did a survey of non-U.S. investors who invest in U.S. real estate and represent about $450 billion in investments on a global basis. Two interesting results from the survey were that, for the first time in a number of years, non-U.S. investors will allocate less than 50 percent of investment dollars to U.S. markets, while, at the same time, the percentage of respondents citing the U.S. as the most safe and secure market globally jumped from 60 percent to 75 percent.

“Taken together, investors are looking at a variety of different global regions to provide them with higher absolute returns, although there will be more risk,” Baillie says.

In the U.S., institutional investors have been ramping up their allocation to real estate both through direct real estate investment and through REITs. With all this capital coming into domestic real estate, capitalization rates have been driven down. Yet, the investors still have to make their investments work, that is, to throw off a decent return.

“Institutional investors are saying the opportunities in our home market due to prices or availability of investment real estate are not where we want them to be, given the amount of dollars we put to work,” observes John Kriz, managing director for real estate finance at Moody’s Investors Service. “We need to look elsewhere for opportunities, either in new geographic markets or new product markets.”

The corollary to this is that U.S. REITs have done so well over the past few years, with a compound annual total return of 19.4 percent over the five years ended June 2006, that some investors worry the returns may not prove as strong in the future and the time might be right for looking at overseas REITs.

“We have encouraged our clients to take part of their allocations to us and allow us to invest globally, and begrudgingly few have,” says Theodore Bigman, managing director and portfolio manager with Morgan Stanley Investment Management. “However, in all fairness, returns have been pretty darn fantastic in the U.S.”

Good returns are not an irrelevant issue, Bigman adds. “For a lot of clients, their REIT account has been their best performing account over the last three to five years, so why fix something if it’s not broken.”

Balance Act

Needless to say, investors don’t just look for returns on an absolute basis, but also portfolio balance through diversification, which is one of the reasons why institutional investors turned to real estate in the first place. Global real estate investing offers an extension of that theme.

“If you are looking globally across real estate securities, what you find is that correlations are quite low among different countries,”says Rick Romano, vice president and portfolio manager at Prudential Real Estate Investors (PREI).

In January 2005, PREI unveiled a fund for non-U.S. investors that is roughly 50 percent invested in the U.S., 30 percent in Asia and 20 percent in Europe.

“In real estate, if you look at the U.S. versus Japan or U.S. versus Europe, correlations are low and there are opportunities to create globally diversified portfolios within real estate,” Romano says.

The Morgan Stanley Investment Management survey supports this assertion. From 1993 through the third quarter of 2005, the correlation of returns between North America and Europe was 0.49; Asia, 0.33; and Australia 0.40.

The survey also reported expanding from a domestic-only real estate portfolio to a global real estate portfolio enhances diversification benefits.

International Investments

The grandfather of international real estate funds is Alpine Woods Investments, which unveiled the Alpine International Real Estate Equity Fund (EGLRX) back in 1989. It’s still rolling along nicely, up 33.8 percent in the past year, 37 percent for three years and 24 percent for five years.

“I would like for that to continue, but honestly, the easy money has been made abroad,” says Samuel Lieber, co-CEO of Alpine Woods. Going forward, Lieber expects that international REIT investing will do 5 percent to 7 percent better than just investing in U.S. REITs.

Today, the fund’s geographic make-up is roughly 45 percent in Europe, 35 percent in Asia, 12 percent in the U.S. and 8 percent in Canada and Latin America.

“From our perspective, there is going to be greater growth in Asia, but more volatility as there are more REITs being created there,” Lieber says.

Meanwhile, CBRE’s Carroll is underweighting Australia and the U.S. and European Investors’s Rehlaender is down on Japan.

“Frankly, we cannot get excited about J-REITs,” Rehlaender says. “That is because we want to invest in companies that can enhance value through active and aggressive management of the underlying portfolios. J-REITs are essentially rent collectors and that doesn’t excite us.”

From an investment banking perspective, Mark Patterson, a managing director at Merrill Lynch, does get excited about prospects in Asia, including Japan.

“There is one of the best positive spread investing opportunities in the world in Japan,” Patterson says. “The Japanese government bond spread is up to 2 percent and there are investment deals of 4 percent to 5 percent on assets.”

As for Europe, “There are still a lot of non-REIT IPOs that are happening,” he says. “However, everyone is waiting for the U.K., where REIT legislation will take effect in January 2007, and then the happenings in Germany.”

One fund that takes a different approach from those who take a regional approach is AIM Global Real Estate (AGREX), which eschews regionalism for solid stock picking. “You might look at our country weightings and come away with a conclusion that might not be exactly right,” says Joe Rodriguez, lead portfolio manager for AIM Investments. “We are essentially picking individual stocks that we think will outperform the benchmark. We are country agnostic.”

Rodriguez must be doing something right, because AIM Global is up 11.2 percent year-to-date as of June 1, 2006 and 27.74 percent on a one-year basis.

AIM Global was unveiled in April 2005 and has launched offshore funds in Australia, Dublin and Hong Kong. Asked why it waited so long to create a fund for U.S. investors, Rodriguez responds, “Major institutional investors don’t make snap decisions with regard to asset allocation. They need to be cautious and make sure this makes sense to them. Once people get into the details, we will see them taking advantage of opportunities around the world.”

There are many ways to participate in the U.S. REIT market, but there are not nearly as many to participate in the global real estate securities evolution, Patterson adds. “The tide is changing. Real estate is becoming more global and investors want to participate,” he says. “As a result, new global products are being created for them to participate in.”