Going Abroad
[September/October 2006]
U.S. REITs Looking
Overseas to
Expand their
Horizons
By Dees Stribling
What do a warehouse in urban Poland, a self-storage property in the U.K. Midlands, and a discount mall near Osaka, Japan, have in common? Seemingly little, exceptthat all three are owned by REITs based in the United States. (Owned respectively by ProLogis (NYSE: PLD), in the case of the warehouse, Public Storage Centers Inc. (NYSE: PSA) for the British self-storage facility, and Simon Property Group (NYSE: SPG) for the Japanese mall.)
Investment overseas by U.S. REITs isn’t new, but the public real estate sector has an increasing appetite for properties outside the United States, and increasing experience in reaping the benefits of foreign property ownership—and in avoiding the pitfalls that can accompany it.
“U.S. REIT investments overseas are still relatively modest, but they’re growing,” says John Kriz, managing director for real estate finance at Moody’s Investors Service. “A number of REITs have ventured into overseas markets, and on the whole they’ve been quite successful with it. So other REITs are becoming more interested. It isn’t the novelty it was only a few years ago.”
Indeed, real estate executives are showing enthusiasm for the idea. According to the law firm Bryan Cave LLP, 61 percent of the 343 real estate executives it surveyed this spring expected to make some kind of investment in overseas real estate within the next 12 months, with China and Mexico cited as the most popular choices, followed by Canada, Japan and the United Kingdom. Included in the survey were both executives from public and private companies, along with commercial mortgage bankers, lenders and others in the industry. Strictly speaking, the findings don’t exclusively define REIT behavior. Yet, they do point toward an active interest in overseas real estate in the industry as a whole.
“We’re very interested in overseas markets,” notes Joseph Padanilam, senior vice president of Developers Diversified Realty (NYSE: DDR), a lifestyle center specialist that’s an example of a REIT that hasn’t yet moved into overseas markets, but is on the verge. “We haven’t made definite plans yet, but we have the money and expertise to do it, and we’re looking all over the world for opportunities.”
“REITs are always looking to grow, so the thinking is, ‘Why let borders stop us?’ ” Kriz says.
Opportunities and Risks
Why go overseas? Because analysts and investors say that’s where the money is. Mature economies such as those in the European Union and Japan are enormous in scale. For example, the EU’s gross domestic product (GDP) was about $13.3 trillion (€10.4 trillion) in 2005, outstripping the $12.5 trillion GDP of the United States that same year. Some emerging markets, with their dynamic growth, are also attractive propositions for real estate investors, though they represent a different sort of playing field.
According to the Central Intelligence Agency’s World Fact Book, China’s real GDP growth in 2005 was 9.9 percent, and India’s was 7.6 percent, just to name the two most important emerging markets.
“There were only a handful of REITs operating outside the United States only a decade ago,” says Al Otero, managing director with European Investors Inc., an asset management firm that specializes in global real estate investing. “After all, the United States is the birthplace of the REIT, and this country is such a large and diverse market that it kept REITs quite busy for a long time.”
But in recent years, Otero notes growth parameters in the U.S. began to constrict, especially for the larger REITs. “It’s like any other business,” Otero says. “Companies need to grow, and they start to look north to Canada, or over to Europe or Asia. It’s a way of maintaining long-term growth rates, especially if they already have a sizable share in the American market, because there’s less opportunity here for ownership even in secondary or tertiary markets.”
Another reason for going overseas now involves the lessening of what Ettore Santucci, a partner with law firm Goodwin Procter’s Business Law Department and chair of its Securities & Corporate Finance Practice, calls “friction costs.” In other words, with globalization, many countries are putting up less resistance to investment in their real estate than they used to.
“Friction costs are how much you have to put up with to do business in a particular country,” Santucci says. “It’s always a little more complicated to do business in another country, even if it’s a familiar one such as Canada or the U.K. It used to be that some markets represented quite a lot of friction, for political, cultural or legal reasons.”
But now, he continues, a lot of markets are moving in the direction of less friction, which is typically characterized by political stability and the greater rule of law. “That isn’t the case everywhere in the world, of course, but in a lot of places it is,” Santucci says, especially in Eastern Europe and much of Asia.
This doesn’t mean the risks of doing business overseas for U.S. REITs, or any American business, have evaporated. For example, currency fluctuations have long been a bane in doing business overseas, though the process is getting less complicated.
“There are various ways to deal with currency issues,” Kriz says. “That is, various ways to hedge the risk. It’s not going to be perfect in every case, but experienced international operations get pretty good at dealing with it.”
More complicated still are overseas tax considerations, which can be a headache for even the most sophisticated operators. “A local partner to take care of tax issues is fairly standard among REITs overseas,” Santucci says. But even so, there can be surprises.
Less predictable are other kinds of legal entanglements, known as transparency issues. Perhaps the most notorious expanding economy for unexpected legal problems is China.
In the monograph “Essential Advice for Doing Business in China,” the Beijing office of the U.S. Commercial Service, which is a branch of the U.S. Department of Commerce that assists business in import/export matters, takes great pains to mention some of the risks: “When entering into a contract with a Chinese partner you must be careful,” it advises. “Do not attempt to enter into an agreement without sound legal advice… Do not rely on legal advice from your Chinese partner. Beware of claims that Chinese law requires specific covenants in your contract… Do not assume that local or provincial officials actually have the authority to give you permits and permissions. Verify their claims of authority through independent sources.”
Another possible risk for REITs expanding overseas stems not from conditions in other countries, but from a poorly thought-out expansion strategy. Going global for global’s sake, or because everyone else is going to China, for example, might not represent a wise course of action.
“Some overseas expansion is ill-conceived, in the sense that the thinking is, ‘We aren’t getting the returns we want in the United States, so let’s try somewhere else,’ ” Otero says. “That’s probably going to be a fundamentally flawed strategy. It’s just like any other business ventureit comes down to the execution.”
Exporting Expertise
When it comes to growing overseas, there are a variety of strategic paths open to U.S. REITs. For Simon Property Group, the world’s largest U.S. mall REIT, expanding to other countries has meant exporting its real estate skill set: building, marketing and running distinctive retail properties. Currently Simon has about 50 properties in Italy, France and Poland, and one in Mexico. Through its subsidiary Chelsea Property Group it also owns five outlet malls in Japan—a good example of a methodical export of a REIT’s skills, with the help of local joint venture partners.
Japan has had a long history of very localized retailing, a fragmented system that resisted change for many years. The introduction of the first big box retailer in the country—Toys R Us in particular—was a long and slow process, and big news when it finally happened in the 1990s.
By the late 1990s, Simon had determined Japan was ready for the outlet mall, a concept the company excels at in the United States (Chelsea has about 50 properties stateside), but which was virtually unknown in Japan.
Partnering with Mitsubishi Estate Co. Ltd., one of Japan’s top real estate companies, and trading company Nissho Iwai Corp. (later, Sojitz Corp. became the third partner), Chelsea developed its first Japanese outlet mall, Gotemba Premium Outlets, in 2000. Ultimately, the project expanded to 390,000 square feet, a behemoth among Japanese retail properties. Located on a highway west of Tokyo between the popular Hakone resort area and Mt. Fuji, the mall was a success.
Since then, Chelsea and its Japanese partners have developed five other outlet malls in Japan, all successful enough to have completed second phases. Currently, the JV is at work on the sixth property, near the port city of Kobe, and is slated for completion next year.
Another approach is to buy wholesale into an overseas market. In a deal inked in June, Archstone-Smith (NYSE: ASN) agreed to acquire Deutsche WohnAnlage GmbH (DeWAG) for about $649 million. DeWAG specializes in residential properties in the major metropolitan areas of Germany. At the time of the acquisition, DeWAG owned about 6,100 residential units in 50 locations across the country.
“This acquisition will provide our company with a local management team and significant opportunities to expand our platform within Germany,” says R. Scot Sellers, Archstone-Smith chairman and CEO. The acquisition comes in the wake of the company’s purchase of a 657-unit apartment portfolio in Berlin by the REIT earlier in the year, and a 822-unit portfolio in Mannheim late in 2005.
Follow Your Customers
For industrial REITs in particular, going overseas has often been a function of following one’s customers. Logistics is now a fully international business, and therefore so is the business of developing and owning distribution facilities. Or at least it can be.
“DHL, FedEx, UPS and the others are essentially in the business of moving boxes around the world, and when they operate overseas, they often like to deal with someone they know from the United States,” says Guy F. Jacquier, executive vice president of Europe and Asia for AMB Property Corp. (NYSE: AMB), which has owned and operated properties overseas since 2002. Its holdings include properties in China, France, Germany, Japan, Mexico and the Netherlands.
Both at home and abroad, AMB typically focuses on properties near major international cargo airports and seaports, the better to promote supply-chain efficiencies for its tenants. “We’re in a strong position in the U.S. air cargo market, and our customers were going to the hubs of the global air transit system, such as Amsterdam, Frankfurt and Paris in Europe, and Hong Kong and Tokyo in Asia,” Jacquier says. “So we did too.”
ProLogis has also followed its customers to distant shores. In fact, the industrial REIT is widely considered one of the pioneers of public real estate expansion into overseas ownership and operations, and its long experience has paid off. Just this May, for instance, the government of China selected a 1 million-square-foot industrial park that ProLogis is developing as the primary logistics and distribution center for the 2008 Beijing Olympics.
Besides China, Prologis has properties in Japan and Mexico and an especially strong position in Europe. “We started in Europe in 1997, and now we have buildings in 11 countries,” says Steven K. Meyer, president and COO of Europe. “Probably the key to our success, and I can’t emphasize it enough, is that we have 255 European employees in European operations, while exactly three Americans are involved. Our employees are not strangers to their markets.”
ProLogis also has had an advantage in Europe, Meyer notes, because “roughly 35 percent to 40 percent of the facilities there were obsolete when we first started looking into investing on the continent,” he says. “That didn’t mean some businesses didn’t lease space in them. But our customers wanted more modern distribution space, both in Eastern and Western Europe.” In France, for example, an update in national fire codes made a lot of its distribution space obsolete, and ProLogis was able to capitalize on the situation by developing new space.
Meyer emphasizes that ProLogis’ commitment to its overseas operations is only going to increase. Just in Europe, for instance, the company has enough land to build 40 million square feet of new properties in the next three to five years. “The opportunities are boundless,” he says.
Ninety-five percent of the world’s population live and do business outside the U.S. It might take extra effort and mean bearing some extra risk to operate overseas, but the rewards are potentially vast. U.S. REITs are poised to take an even greater piece of a very large property pie.
“For more REITs, investing outside the United States will become more of a ‘Why aren’t you?’ issue rather than a ‘Why are you?’ one,” Kriz says. Although there are some clear risks in such strategies, such as tax, currency hedging and local market knowledge, the opportunities for outsized returns are there, too. “Several U.S. REITs, such as Simon Property in regional malls, and ProLogis in warehouses, have developed strong, hard-to-find skills in property development and management, and excellent tenant relationships,” he says. “It would be a shame not to prudently use those talents to their full.”
Dees Stribling is a real estate writer based in Illinois.
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