The lessons of the last few years, as painful as they have been, are few and simple. Among them:
• Bubbles eventually pop.
• A broad downturn across the whole economy can spell trouble even for investors with diversified portfolios.
• The effects of a deep recession can linger for a long time.
Astute financial advisors have always known that risk cannot be eliminated, but it still must be managed to help investors achieve their goals despite what happens in the economy at large.
With inflation looming and memories of the Great Recession still fresh, many advisors are seeking new ways to manage and minimize risk, while also trying to respond to clients’ desire for inflation-beating returns. Global real estate investments have the potential to help advisors meet these goals.
A quick word about definitions here: “Global” generally refers to investments anywhere in the world, including the United States; “international” typically means investments outside the United States. While we see many opportunities in domestic real estate over the next three to five years, we believe that including U.S. and international real estate in a portfolio as part of a global strategy has the best chance to minimize risk and maximize returns.
Why Go Abroad
The first question, of course, is “Why go abroad at all?” After all, the United States remains the world’s largest and strongest economy. Certainly, the first place advisors should create diversity is within their clients’ portfolio of U.S. investments.
However, a global real estate strategy can be a powerful tool to help advisors manage risk and maximize returns over the long run. There are several reasons why international real estate can potentially help portfolios perform better.
Hedging against the economy as a whole. The first reason to seek international investments is to reduce exposure to overall U.S. economic weakness. No matter how well-diversified a portfolio is within the United States, if the overall economy slows, returns could fall. Investing in international assets allows advisors to take advantage of opportunities abroad that may perform better. If the U.S. economy is down while the Australian or Japanese economies are up, for example, it makes sense to have investments in those stronger economies. This is geographic hedging, similar to the way advisors might hedge against potential losses in equities by buying alternative investments. Though none of us look forward to economic slowdowns, the American economy, as in the past, likely will continue to have its ups and downs. Hedging against down years by putting money to work elsewhere can reduce overall portfolio risk and potentially increase long-term returns.
More investment opportunities. An advisor’s ability to manage portfolios is limited, in part, by the number of investment choices available. The more choices there are, the more opportunities advisors have. In commercial real estate, this is especially true. While the U.S. commercial real estate market is very large, it only contains a portion of the entire world’s commercial real estate. Over the coming decades, U.S. real estate assets are projected to shrink as a percentage of total global real estate assets. According to Prudential Real Estate Investors, the U.S./Canada commercial real estate market comprised 30.2% of the global commercial real estate market in 2008. If projections hold, the U.S./Canada share will shrink to 26% by 2028. While the U.S./Canada market may grow over those decades, there likely will be even more opportunities overseas.
In addition, the ability to deploy capital to multiple markets overseas potentially allows investors to take advantage of better buying and selling opportunities. Real estate values in different markets are generally asynchronous. While prices in one market may be topping out, a perfect time to sell, prices in another market may be near their bottom, a good time to buy. With options to buy or sell in multiple markets, investors can deploy capital more efficiently based on where the best returns are likely to be.
Faster growth in emerging economies. It is a nearly unanimous forecast that emerging economies in places such as Asia will grow faster overall than mature economies in North America and Western Europe over the coming decades. This economic growth will, as it previously has, drive commercial real estate growth. Developing countries will need more factories, warehouses, office buildings, shopping malls and apartment buildings than the United States, Canada and other industrialized countries. The growth in demand for commercial real estate will drive up the value of quality assets in those emerging markets faster, on average, than in mature economies. Investing in commercial real estate in these countries is a way to tap potentially higher returns than generally would be found in the United States.
Why Real Estate
Global diversification in investing is not new. But it’s fair to ask why advisors should choose international real estate investments as part of the overall global asset mix.
Through international real estate, advisors can build further diversification into client portfolios. As in the United States, real estate investments, particularly through non-traded funds, are not directly correlated to public stock market returns. This provides advisors another tool to manage risk.
Finally, real estate, like other physical assets, can potentially provide a hedge against inflation. Inflation remains a threat in the United States, but could also be a concern in other countries. Hard assets such as real estate provide some protection from this, making it a valuable tool for advisors able to deploy capital abroad.
Evaluating International Real Estate Investment Opportunities
Investing in commercial real estate internationally requires expertise that few financial advisors are likely to have. As in the United States, an efficient way for investors to harness this asset class is to purchase shares in a company, such as a real estate investment trust (REIT), that specializes in global real estate.
While advisors may be familiar with the major real estate investment managers and sponsors in the United States, not all of those have the expertise required for success abroad. In addition to knowledge of local markets, international real estate investment also requires expertise in foreign law, tax rules, knowledge of foreign business and real estate practices, and the ability to manage currency fluctuations.
There are two major considerations in assessing international real estate investments: the investor’s goals and the investment manager’s experience and global presence.
Investor goals. Considering investor goals is second nature to advisors, but it’s worth considering specifically how international real estate might meet different objectives—growth, current income or a mix. International real estate has the potential to help investors reach any of these goals, but different types of assets will be involved.
Growth-oriented investors should seek investments where the manager/sponsor is focused on assets that are undervalued compared to their replacement cost and potential long-term value. That could mean buying properties in markets where the price cycle is at a low point, or it could mean buying properties that are underutilized or require improvements or other changes to maximize value.
For an income-focused investor, investment managers should be seeking properties with high occupancy rates located in strong local economies. Investment managers may also seek other real estate-related investments, such as real estate debt and securities. These would take advantage of the opportunity for current income from interest payments.
An advisor who wants a mix of income and growth assets could allocate funds to multiple REITs, each of which has either a growth or income goal, thereby selecting a mix of income and growth based on client needs. Advisors could also choose a REIT that strategically seeks current income plus potential capital appreciation.
Investment manager experience and global reach. Navigating international real estate is more complex than operating in one nation. Owning and managing assets in several countries requires specific expertise and an international presence. When evaluating this, advisors should consider the sponsor or investment manager’s experience managing through multiple economic cycles. Advisors also should ask how much experience the investment manager, sponsor or advisor has acquiring and managing assets. Key to this is whether the sponsor or advisor has “boots on the ground” in various countries. Even globally, all real estate is local.
While the case for global real estate investment is relatively simple to make, actually acquiring and managing such assets is complex; having real estate professionals based in individual countries is critical. Many U.S. investors are paying more attention to global real estate than they did a few years ago, a trend that seems likely to continue. Advisors must understand the value of this asset class, but must also appreciate its complexity. Ultimately, identifying a good “partner”—a sponsor or investment manager with the requisite experience and knowledge—is vital to ensuring that international real estate plays a positive role within an investor’s portfolio.
Andy Hyltin is president and CEO of CNL Fund Advisors Co., where he oversees the REIT investment funds that have resulted from CNL’s strategic partnerships with global financial institutions.