Through the Roof

When the Internet boom hit Ireland in the early 1990s, one of the first sectors of the economy to benefit from the creation of new jobs and the spike in wages was the real estate market.

“People began very quickly to go all out looking for better housing for themselves, and this led to a huge boom in real estate,” says Barry Strudwick, president of investment advisory firm Strudwick Wealth Strategies.

That same phenomenon, says Strudwick—an expert in international real estate and a long-time believer in its investment advantages—is happening today in the emerging markets, and it’s the reason why emerging market real estate makes for a compelling investment opportunity. The emerging market economies are among the fastest growing economies in the world, he says, and “there’s a new class of consumer in these countries that are looking for more and better real estate. Whether it’s for office parks, condos or shopping centers, we’re seeing a great deal of construction that’s meeting that demand.”

Everyone knows that the emerging markets asset class has been a hot bed for cashflow over the past several years. Rick Genoni, product manager for ETFs at Vanguard, says that Vanguard’s emerging market products (including its Global ex-US Real Estate ETF) have been attracting unprecedented attention. As more advisors have been considering emerging markets as a tactical play in their clients’ portfolios, the need to make that exposure more targeted and specific has also been growing. The market for international REITs and REOCs has also grown, which means that emerging markets real estate has become more interesting as an asset class unto itself, Genoni says, and it is being increasingly included in both funds and ETFs.

“On a market cap basis, we don’t expect emerging market real estate to be a large part of a client’s underlying asset allocation, but on a tactical basis, if you think there will be unprecedented growth and you expect REITs to take off, it’s a good play,” he says.

Of course, emerging markets real estate is still a fairly niche area and it has not yet attracted the attention that investors like Scott Crowe, senior vice president and global portfolio manager at Cohen & Steers, believe it should. That’s because investors have not been able to access this asset class to the extent that they could be through existing global or emerging market equity allocations, Crowe says, since benchmark indices just don’t have sufficient allocation to emerging market real estate. The MSCI World Index, for example, has no emerging market real estate exposure and the MSCI EM Index has a mere 1.7% allocation to emerging market real estate.

Yet about 8% of the $1.2 trillion global universe of listed properties is in emerging markets, Crowe says; 12% of the world’s underlying real estate is also located in these countries. Looking at things from a GDP-weighted perspective, emerging markets make up 33% of global GDP, so having some allocation to emerging markets real estate makes sense.

It is for this reason that investment managers like Crowe are setting up new funds to offer investors dedicated and direct exposure to emerging markets real estate. Cohen & Steers has already been investing in emerging markets real estate for four years through its global real estate funds, “but as the universe expanded, we decided to launch a dedicated emerging markets real estate fund to make it easier for investors to have access to this asset class,” Crowe says. “We may be a little early with this fund, but we see a great long-term future for this asset class because of the secular emerging markets story, and we believe that the best way to get access to their underlying economic dynamics is through real estate.”

Strudwick also believes that clients looking for targeted emerging market exposure would fare well with some allocation to real estate. But, he warns, this is still a fairly marginal area that is hard to get a proper handle on from the United States, particularly when it comes to assessing REITs and real estate companies on corporate governance. So while there are certainly opportunities for investors, those who are considering emerging markets real estate should definitely go with managers who have experience in international real estate investing, who know how to assess tax codes in different countries, who have the means to vet out management teams and who can perform proper due diligence.

To date, the number of investment products offering exposure to emerging markets real estate are few (Vanguard’s ex-US Global Real Estate ETF was one of the first ETFs to have an allocation to the asset class). But Strudwick believes that there will be a growth in product offerings as more people realize the benefits of the asset class.

Here’s what the experts have to say:

Scott Crowe, Cohen & Steers’ Emerging Markets Real Estate Fund

Crowe believes that the emerging markets inflation scare, which dominated news headlines for some months and frightened people enough to withdraw their money from the asset class, won’t have any lasting impact on emerging markets. On the contrary, he says, developed markets are mired in such deep straits, that it will take them a long, long time to recover, and this makes emerging markets in general, and niche segments like real estate in particular, look very attractive by comparison.

“I think we’re on the cusp of a dramatic shift back into emerging markets and because of that, I expect that our fund will generate a lot of interest going forward,” he says.

Launched in March, Cohen & Steers’ $60-million Emerging Markets Real Estate Fund invests in a mix of REITs and listed property companies in the Asia-Pacific region, Latin America, Central and Eastern Europe and South Africa. The fund was one of the main investors in the first Mexican REIT IPO, Crowe says, and it has a positive outlook on the development of the REIT market.

“They are a powerful catalyst to drive the securitization of real estate,” he says.

Thus far, REITs have been introduced in only a few emerging market countries, such as Mexico, Malaysia and China. But other countries like the Philippines are working on getting REIT legislation in place, Crowe says, so “I expect the REIT universe to grow going forward. We have already seen numerous new REIT IPOs in countries that are creating more infrastructures for a service-based economy, where you need malls rather than markets to service growing needs, and where you need hotels. All this goes hand in hand with the economic development of these countries.”

While he sees opportunity in many emerging market countries, the standout nation for Crowe is Brazil.

“It has more of the benefits and less of the pitfalls of emerging markets,” he says.

Brazil has a solid economic framework, bolstered by a strong central bank that has a firm hold on inflation. It benefits from natural resources and derives strong export revenues from these, but most importantly, Brazil is a functioning democracy that is fully committed to capitalism, Crowe says. Unlike China, which has had a thriving real estate market but has, in Crowe’s opinion, only made a “half-hearted commitment to capitalism,” Brazil is going the whole hog and this is important for the growth of all sectors of the economy, including real estate.

“When you have a country that’s fully committed to capitalism, you do find management teams that are better incentivized,” he says. “I think Brazil offers the best long-term opportunities because of its strong foundations and this is why it’s our largest overweight.”

Crowe believes that more firms will look to launch dedicated emerging market real estate funds and that the asset class will continue to generate interest going forward for anyone who wants to diversify their emerging markets exposure. But, he cautions, it is important for both managers and their clients to be fully aware of the risks of investing in emerging market real estate. It isn’t just that the asset class is relatively new; each emerging market country is different and unique, he says, both culturally as well as developmentally. Regulatory environments are also different, and all this comes to bear upon the real estate market.

“We took three years understanding management teams and underlying property types, so I wish our competitors well as they get their strategies going,” Crowe says. “Corporate governance is also challenging, so as much as there are opportunities in emerging market real estate, there are also a lot of differences between the various markets. As an investor, you really have to understand those and be able to work through them.”

Michael McGowan, Forward Funds’ International Real Estate Fund