NEW YORK — As most folks know, real estate is all about location. And for real estate investors, that location increasingly does not bear a United States ZIP code.
Lately, foreign real estate investment trusts, or REITs, have been looking especially enticing as US real estate holdings began to wobble after seven straight years of huge gains. So those looking for a good investment have been taking a hard look at overseas REITs or global REIT mutual funds.
REITs are tax-free investments that, like stocks, trade on exchanges, giving investors a transparent and liquid way to tap into a variety of holdings – malls, hotels, office parks, skyscrapers, etc. REITs pay out some 90 percent of income derived from such properties as dividends. Little wonder they have been such a popular investment in the US over the past seven years or so.
Over the past few years, foreign regulators have given the green light for the development of REIT markets in Europe and Asia, solving a liquidity problem that kept American investors away in the past.
"Investors have come a long way in terms of including real estate in their portfolios," says Christina Chiu, a research analyst with Morgan Stanley Investment Management's Global Real Estate team. "We expect this to continue as a global real estate market evolves and gains acceptance as a distinct asset class."
According to the National Association of Real Estate Investment Trusts (NAREIT), more than 20 countries have created REIT-like structures, and more are seriously considering doing the same. Within the past five years, France, Hong Kong, South Korea, Taiwan, Singapore, and Japan have established regulatory frameworks for REITs. Other countries that already offer REIT-like structures include Canada (since 1993), Australia (since 1971), the Netherlands (since 1969), and Belgium (since 1995). Britain legalized REITs as of Jan. 1, 2007. Germany also is moving in this direction. as well.
About a dozen REIT companies in the US have expanded their businesses to include international exposure. The largest player is ProLogis, with properties in Asia, Europe, and North America. Others include Kimco Realty Corp, Mills Corp., AMB Property Corp., Simon Property Group, and Shurgard Storage.
According to NAREIT, American REITS have handily beaten all major benchmarks over periods of three, five, 10, and 15 years. But cold air is setting in. Current yields of domestic REITs are hovering around 3.8 percent – down from recent highs of 7 to 8 percent. So it's little wonder the hot money in this sector is moving in the direction of foreign real estate investments.
"We expect the same kind of situation that prevailed in US REITs will occur in foreign countries," says Louis Stanasolovich, president and CEO of Legend Financial Advisors Inc., in Pittsburgh, Pa. "The recent move going into foreign REITs is relatively new. At this point, it's effectively been a trickle, but it could be the start of something big."
Indeed, some mutual fund companies have begun to offer this foreign asset class. Big names like Morgan Stanley, Fidelity Investments, and AIM Investments are leading the way.
"Most of these firms had domestic REIT funds for years," notes James Reilly, a certified financial planner with RegentAtlantic Capital LLC in Chatham, N.J. "Now they're adding international REIT funds."
Altogether there are approximately 70 global real estate funds, according to NAREIT. Most of the growth has been recent. In 2006, AIM, DWS Scudder, Goldman Sachs, The Kensington Funds, Northern Funds, and Dimensional Fund Advisors launched foreign REIT funds. Cohen & Steers, a money-management firm specializing in REITs, started two such funds in 2005, and Fidelity opened one in 2004.
Today, more financial planners are recommending that international REIT funds be part of investors' portfolios. Part of the allure is diversification on two counts: first, within mixed-asset portfolios and, second, geographically. Investors have the opportunity to broaden their portfolio exposure in REITs in other countries and on their exchanges as well. There is also a low correlation of returns between real estate securities listed in North America and those in Europe and Asia, according to Morgan Stanley figures.
"This provides exposure to varying economic cycles, varying rates of return, and higher yields," says David Taube, founder and president of Kalorama Wealth Strategies in Washington, D.C. "Companies and investors are seeking acquisition opportunities outside the US because the US property market is very competitive. There has been significant property return compression over the past decade."
Another reason the fire is burning is performance. According to NAREIT, real estate securities, of which REITs are a part, have outperformed other equities and government bonds around the globe, providing double-digit returns over time periods of five, 10, and 20 years. Foreign commercial real estate is also currently selling at more attractive valuations than US commercial real estate. "Foreign REITs are a bit cheaper than US REITs," says Mr. Stanasolovich.
One caveat: Don Cassidy, senior research analyst at fund tracker Lipper Inc., warns against investors chasing performance. "This movement reflects two predictable trends: product differentiation and the chasing of performance by investing internationally," he says. "It makes sense to have some international property exposure, but it is interesting to note that the interest is coming now, after a huge run, rather than earlier, when prices were lower."
Investors should be forewarned that most of these funds are young, with limited track records, and some economies, particularly in Asia, are more volatile, Mr. Cassidy says.
Indeed, the risks of investing in foreign REITs are similar to the risks of investing in international stock markets: limited public information; less liquid trading; and a range of different political environments. There is also the added cost of investing in foreign markets. International REIT funds tend to have higher expense ratios than their US counterparts, Cassidy says.
Other challenges investors face include logistics, language barriers, and different reporting standards. "Real estate is still a local business. You need to have local market knowledge and know the customers," says Mr. Taube.