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February 01, 2011 at 07:00 PM
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.
