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REITs Go Global Welcome to the brave new world of international real estate securities
Whether you agree with Scarlett O’Hara’s Dad or
not, there’s no denyin’ that land—if not Southern plantations, then certainly
modern malls, condos and hotels—has been an awfully good investment of
late. For calendar year 2004, the nearly 200 United States-based real
estate investment trusts (REITs) that collectively make up the NAREIT
Composite Index returned 31.6 percent. Over the past five years, the Index’s
compound annual return has been 22.0 percent, and over the past 10 years,
14.8 percent. Not even vintage Pez dispensers have done that well, never
mind plain vanilla stocks and bonds.
Some holders of REITs believe (fervently hope)
that such phenomenal performance will continue. Others argue that the
glory of REITs may already be gone with the wind. While the jury is out,
a growing number of financial planners are starting to hedge their bets—not
by reducing their REIT allocation, but by internationalizing it.
“We continue to believe, as we have for some
time, that eight percent of a typical client’s portfolio should be committed
to real estate securities. However, we now advise that three of that eight
percent should go into foreign rather than U.S. securities,” says Chris
Cordaro, a principal of Regent Atlantic Capital, LLC, a New Jersey-based,
fee-only investment firm with nearly $1 billion in assets under management.
Mark Gleason with Wescap Management Group
in Burbank, California, a fee-only
firm with $400 million under its wing, is similarly sending a portion
of his REIT allocation packing. “We’ve currently got six percent of our
portfolios in real estate—of
that six percent, four percent is U.S., and the other two is foreign.
We may be adjusting that that soon to equal allocations of U.S. and foreign.”
Planners such as Gleason and Cordaro, had
they wanted to invest in foreign real estate several years ago, would
have struggled to find the means. But of late there has been something
of a revolution in foreign property ownership. “What we’re seeing abroad
right now is very reminiscent of what happened in the U.S. in the early 1990’s,” says
Joe Harvey, president of Cohen & Steers, Inc., America’s largest REIT
management firm. REITs existed in the U.S. since the 1960’s, but didn’t
really take off until the early 90’s when the U.S. real estate market
found itself in a liquidity crisis, explains Harvey. “Savings and loans
were in trouble and weren’t lending. Property companies that wanted to
expand had no option but to go public.”
Now, says Harvey, somewhat similar conditions prevail in many
other countries—not necessarily S & L crises, but a definite push
for public ownership of property management companies. Australia and the
Netherlands have had REITs or REIT-like structures since the early 1970’s;
Belgium and Canada since the early 1990’s. In none of those countries,
however, does the market cap for such securities even touch the market
cap of U.S. REITs ($248 billion, not including mortgage REITs). The room
for growth in such nations is enormous, says Harvey.
In other countries, including Japan, France, and Korea, REITs or REIT-like
trusts are much more recent inventions. There, too, the market can seemingly
only grow. And in the case of Germany, Italy, and the United Kingdom—nothing
quite resembling REITs yet exists, but plans are on the drawing board.
(Although there are other kinds of real estate securities presently available
in those countries.)
With the growing availability of foreign REITs,
as well as other publicly traded real estate securities, a handful of
firms—including biggies Morgan Stanley and Fidelity—now offer global real estate funds to American
investors. And a number of others, including Cohen & Steers, have
such funds currently in development. (For a view of what’s presently available,
see Short Shopping List)
But, of course, just the fact that international
real estate funds are now available is not reason enough to buy them.
There are other reasons. “Low correlation is one thing I like about foreign
real estate,” says advisor Gleason. “We’re seeing low correlation not
only to U.S. REITs, but to all other asset classes.” Gleason’s
observation is on the mark. A comparison of the S&P/Citigroup BMI
World Ex-U.S. Property Index to the NAREIT Index reveals a correlation
of 0.38 percent for the 15 years ended December 31, 2004. Correlation
to the S&P 500 was practically non-existent.
Lack of correlation is especially tempting
in these days of multinationalism, which has tended to wither any differences
between U.S. and foreign equities,
at least in the large-cap arena. When General Motors ails, chances are
that Volkswagen is ailing too. Not so in the world of REITs—for
good reason. “What could be more local than real estate?” quips Gleason.
“Of course,” he adds quickly—“low
correlation doesn’t mean much if you’re not making money.” But not making
money is a complaint you are unlikely to hear from recent investors in
international real estate. Consider that the aforementioned S&P/Citigroup
BMI World Ex-U.S. Property Index ballooned 18.57 percent in the 12 months
ended January 30, 2005.
Of course, anyone who has ever read a prospectus
knows (or should know) that past performance is no indicator of future
results. So let’s ignore past performance. Might anything give international
real estate securities an edge for the future? Advisor Cordaro thinks
so. “U.S. REITs are pretty richly priced right now; we see better valuations
out there beyond the U.S.,” he
says. In fact, industry analysts estimate that U.S. REITs are presently
selling at a 13 percent premium over their net asset value. In contract,
foreign real estate securities are selling roughly at par.
And in addition to those more tempting valuations,
adds Cordaro, “as icing on the cake,” further devaluations of the dollar
will translate into extra spice for any U.S. investor of foreign securities. “Given the rising
deficit and a number of other indicators, we think the dollar is much
more likely to fall than to rise against other major currencies,” says
Cordaro.
Harvey of Steers & Cohen points out that
recent initial public offerings (IPOs) of foreign real estate securites,
especially in the Far East, have
all done very well. He sees the future of such securities following a
similar tangent as the dozens of IPOs that took off in the U.S. over the past 20 years. “History doesn’t repeat,” he says—“but it often rhymes.”
Steve Buller, long time manager of Fidelity’s
Real Estate Investment Portfolio, recently took the reigns of Fidelity’s
new International Real Estate Fund (FIREX). Buller is pleased—and who wouldn’t be?—with the 17 percent return he’s garnered in
only the first five months, but he isn’t so presumptuous to think that
such a pulse rate will continue forever. “What should you expect the
long-term potential to be? I’d say this lends itself to an eight to ten
percent annual return,” says Buller. “Of course, you should also expect
some volatility, because you have both the value of the securities and
the currency factor.”
For those planners who want to massage a position
in foreign real estate into their portfolios, know that foreign REITs
work much like U.S. REITs. “In the long-run, I expect that about one-third
of the total return from this fund will come from dividends, for these
are some of the highest dividend paying stocks on the market,” says Buller.
“It is not, therefore, the most tax efficient of investments, so if you
have the ability to do so, put this fund into a tax-preferred account.”
Buller, by the way, unlike planners Cordaro
and Gleason, doesn’t see international real estate as a sub-allocation
of or substitute for U.S. REITs. “We see this fund more as a diversifying
tool for someone’s international exposure,” he says. “With international
real estate, just as with other foreign equities or fixed income, you
bring currency into the equation.” Still, even with currency in the equation,
international real estate correlates 0.65 with international equities,
and 0.3 with international fixed income.
Harvey of Cohen & Steers doesn’t take
a strong position as to where foreign real estate holdings might be housed
within a portfolio. “I look at foreign real estate either as a compliment
to a U.S. REIT allocation or as a stand-alone asset class.” Whichever
way you cook it, he says, owning some bricks and mortar in Europe or Asia is a good investment.
Of course, as more money spills into international real estate, as seems inevitable, additional players will enter the field, and financial planners will have greater choices of funds. There will also be greater discussion, and perhaps the profession will resolve exactly where in a portfolio international real estate belongs. But that’s all coming tomorrow… and tomorrow, as Scarlett O’Hara says, is another day. Alpine International Real Estate Equity Fund
(EGLRX) Fidelity
International Real Estate Fund (FIREX) ING Global Real Estate Fund (IGLAX) Morgan Stanley European Real Estate Portfolio
(MSAUX)
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