By Kelly Whitman

As is evidenced by the theme of the 2004 NAREIT Annual Convention, real estate investing has taken on a global feel. Investment flows have been picking up as investors seek to deploy a rapidly growing pool of real estate capital and to reap a level of portfolio diversification that can be aided by international investing. Capital has been flowing not only on the private equity side but also into public equity, both through cross-border investment in U.S. and foreign REITs and via U.S. REITs that are building international portfolios. These REIT vehicles make it easier than ever for investors to gain a form of exposure to international real estate.

		Cross-correlations of Annual Rental Growth (1993–2003)

International real estate investment is not a new phenomenon; British, American and Japanese investors, among others, made notable global strides in the 1980s. However, the havoc wrought by the early 1990s down cycle left many international investors stranded—and burned. As a result, investors in most countries have stayed close to home over the past decade.

Due to a variety of factors, real estate capital has been venturing abroad again recently. Investors have a lot of capital to invest and are finding that by casting wider nets, they can harvest more lucrative opportunities. The strong performance of publicly traded real estate relative to other investment options such as stocks and bonds, as well as healthy income returns, has attracted a rising tide of real estate capital, leaving more to spill over across the borders. Legislative and regulatory changes in other markets such as Germany have freed up more capital for international investment. Furthermore, the introduction of REITs and similar vehicles in markets such as Japan, France, Australia, and, perhaps soon, the U.K., have eased the flow of capital in and out of international markets. Adding an international component to a real estate portfolio provides significant diversification benefits. The very local nature of real estate means that there are many structural differences—from ownership to tax issues to market transparency to size and liquidity and lease characteristics—all of which affect the level of inherent structural risk in a market or country. These structural differences, combined with variations among economic cycles, produce relatively low cross-correlations between many global real estate markets.

These low correlations allow investors to hedge against varying global business and real estate cycles. For example, due to differences in cyclical timing as well as lease structures, rent growth in Asian markets such as Hong Kong, Shanghai and Tokyo have very low or even negative correlations with rent growth in major U.S. markets. These relationships are very useful from a portfolio perspective, as when some markets are experiencing rising rents, others may be slowing or even falling, reducing overall volatility.

The core U.S. cities and London are arguably the most desirable markets, offering the most liquidity, transparency, and well-protected property rights. Structural risk here is very low. At the other end of the spectrum are the emerging markets in Asia and Eastern Europe, which are far more volatile in terms of both economic cycles and real estate performance. The risks (and potential rewards) are greater in these markets, as real estate markets and financing tools are still developing in those countries.

Falling somewhere in between are countries such as Italy, Germany and Spain, which have mature financial markets but relatively small institutional markets due to a high share of owner-occupancy. International investment allows firms in these countries to build a larger and more diverse portfolio than is available by just investing domestically.

For investors looking to take their portfolio diversification to the next level, investing in listed REITs with global exposure is a great place to start. Plenty of U.S. REITs are upping their global holdings; for example, industrial REITs such as AMB Property Corporation (NYSE: AMB) and ProLogis (NYSE: PLD) own large distribution centers not only in core U.S. markets such as Northern New Jersey and Los Angeles but also in Warsaw and Tokyo.

Another vehicle for increased global exposure is direct investment in the increasing number of foreign REITs, thereby adding shares of Parisian apartment buildings, New Zealand shopping centers, or Tokyo office buildings to a portfolio. Indicative of the growing number of opportunities presented by the emergence of foreign REITs, NAREIT, the European Public Real Estate Association (EPRA) and the Euronext Stock Exchange teamed up in creating a global real estate benchmark. The EPRA/NAREIT Global Real Estate Index contains approximately 250 companies with a combined market cap exceeding $400 billion.

Gaining this kind of exposure and diversity on an asset-by-asset basis is unattainable for all but the largest of investors. However, international REITs and U.S. REITs with a global portfolio bring global real estate within reach.

Kelly Whitman is a research strategist for Property & Portfolio Research.