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Foreign REITs: Profits and Perils for Investors

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The diversification benefits of real estate investment trusts are well established. But many investors limit their investments to U.S.-based properties.

That’s understandable: The domestic REIT structure provides transparency and the trading market is liquid.

This constrained approach, however, imposes an opportunity cost. Namely, it overlooks additional diversification benefits and a wide range of profit opportunities in other countries. 

REITs are a tax structure created in the U.S., says Nina Jones, CPA, manager of the T. Rowe Price Global Real Estate Fund (TRGRX) in Baltimore, Maryland. Some countries have adopted similar structures for real estate investment funds based in their country, but the processes are not universal.

Nonetheless, the foreign funds’ business models for investing in commercial real estate such as retail space, office buildings, industrial properties and hotels are very similar to U.S. REITs, she explains.

The funds’ activities consist of “buying those properties or developing those properties, trying to increase the rent and occupancy, generate … increasing cash flow from the properties and, with good management and a good market environment, you can make a good amount of money in commercial real estate,” according to the fund manager.

Overall, Jones rates foreign REITs’ transparency and market liquidity as “pretty good” and believes both conditions rank slightly below the U.S. levels but are improving. 

Potential Diversification, Added Risk

The arguments favoring foreign real estate investments are essentially the same as those for foreign stock and bond investments. The macroeconomic environments in foreign property markets often differ from those in the U.S. Their economies can be in different phases of the economic growth cycle, their demographics — particularly where the middle class is emerging — can be dramatically different, and their prevailing monetary policies may be tighter or looser. 

The regional year-to-date returns through June 12 in U.S. dollars as measured by the FTSE EPRA/NAREIT Global Real Estate Index Returns illustrate how returns can vary in the short term. The Americas’ total return for the period was -4.19%, but the Asia/Pacific index grew by 5.16%, and the Europe index increased by 5.8%.

(EPRA, the European Public Real Estate Association, represents Europe’s publicly listed property companies and is based in Brussels.)

Investors need to factor in currency swings with foreign REITs. 

Consider the five-year, compounded total returns reported in local currencies by FTSE EPRA/NAREIT: Americas: 12% (U.S. dollars); Europe: 17.85% (euros); and Asia/Pacific: 18.01% (Japanese yen). When those returns for the same period are expressed in U.S. dollars, however, the impact of foreign exchange rate movements becomes clear: Europe returned 15.10%, and Asia/Pacific, 10.90%.

Foreign REITs also exhibit the same short-term interest-rate sensitivity as U.S. trusts, Jones notes, although the ultimate valuation drivers are the properties’ fundamentals.

On the Ground

Macroeconomic trends are important, says Jones, but she emphasizes the need for solid stock research.

“We typically don’t take large country bets,” she explains. “That being said, when you’re doing bottoms-up analysis, sometimes you see more in one country that you’d like to buy just because the valuations are more attractive or the underlying fundamentals are more attractive. And, so, naturally, you still end up with smaller country bets once you add up all the bottoms-up stock picking.”

Still, Jones adds, it’s critical to understand local market conditions, since macro-level trends that appear to support an investing thesis don’t always develop as expected: for instance, the macro thesis that the growth of India’s middle class and its resulting higher levels of disposable income would benefit shopping malls.

The income didn’t materialize as anticipated, and a glut of new retail space has led to empty malls, according to a recent report in The Wall Street Journal.

The way to avoid those investment mistakes is to research the markets onsite, Jones says. To that end she spends several months each year traveling within foreign markets to meet with analysts and real estate companies.

“It’s very important to go and learn the markets firsthand, walk the properties with the management teams and understand what people own, where people live, where people work and why that is, in order to understand if you’re making a good real estate investment long term,” she explains. 

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