Reconsidering real estate

The UBS report anticipates that unleveraged core real estate in mature markets will provide a total return in the range of 3.5%-5.5% per annum and, in the long term, will deliver a total return somewhere between that of stocks and bonds.

In making the case for global real estate investing, Paul Curbo, senior director and real estate portfolio manager with Invesco Ltd. in Dallas, who shares portfolio-management responsibilities for Invesco Global Real Estate Fund (units of which are available to Canadian investors), says: “The asset class offers a competitive total return and has pretty much outperformed equi[ties] and fixed-income over the long term.”

That said, Catherine Ann Marshall, vice chairwoman of the CFA Society Toronto‘s risk-management and alternative asset committee, advises that real estate “moves in a completely different way to stocks and bonds.” She suggests that real estate is a “perfect addition” to a portfolio and is an “excellent income alternative to bonds.”

Furthermore, she advises, investing currently in a “bond portfolio represents the absolute biggest systematic risk, [and] real estate is an excellent way to take some money off the fixed-income table and yet not reduce income.”

Typically, investing in real estate comprises of the commercial sectors, which include office buildings, retail complexes such as shopping malls, industrial complexes, apartments and leased units rather than owner-occupied residential buildings, which are less common investment vehicles. Non-core areas, such as debt secured by real estate assets and hotels, also can be explored.

However, Marshall cautions: “You start to take on some additional risks when you invest in non-core real estate.” For example, she says, hotels operate on a “one-day lease [and are] extremely cyclical.”

When it comes to investing in real estate debt, Derek Warren, portfolio manager with Morguard Financial Corp. in Toronto, highlights the risk: “You don’t go broke buying real estate, but you can go broke financing real estate.”

Your clients can gain access to real estate investments through two main routes: public vehicles, such as real estate companies’ shares, real estate mutual funds or real estate investment trusts (REITs); and direct investments in physical assets or private funds.

Investing in public vehicles offers liquidity but is subject to market forces, which can lead to price volatility. Physical assets, on the other hand, says Marshall, “have great price stability, [but] you must be prepared to tolerate the illiquidity” of such investments.

When looking to invest in real estate, Marshall says, the very first place most investors look to is the home market.

But Matthew Johnson, portfolio manager with UBS Global Asset Management Inc. in Chicago, warns: “Canada is a very small market, accounting for 3% of the investable market globally.” And, he adds, Canada’s big pension funds dominate large transactions, limiting the opportunities available to other market participants.

Johnson also argues that because Canadian real estate was not repriced during the 2008-09 financial crisis, valuations have remained relatively high compared with other markets globally. This reduces the scope to make capital gains from Canadian investments. He also contends that “yields are relatively low,” although there is potential for expansion in the capitalization rate (the ratio between the net operating income produced by a real estate asset and the original price paid to buy the asset).

However, Warren sees Canada as a “safe source for dependable yields,” adding that “Canada has a very mature REIT market that has tended to have higher yields than global markets.”

Opportunities for investing in global real estate vary across different regions. According to Curbo: “Right now, all major markets around the world are experiencing improving commercial real estate conditions.”

He suggests that this is due to the lack of new construction, especially in the developed world. As a result, lease terms are shorter as occupancy and rents rise, resulting in industrial properties, hotels and apartments performing better due to increased in cash flows.

Curbo sees compelling valuations in regions such as Hong Kong, which has strong growth characteristics and is valued at a discount to net asset value; and in New York’s office market, which is benefiting from higher tenant demand from non-traditional users – mainly the technology, media and telecommunications sectors.

Opportunities vary by property type around the world, Johnson says. For example, he is bullish on industrial properties in Australia and the U.K. and on retail properties in Canada and the U.S. Further out the risk spectrum, Johnson sees opportunity for new acquisitions in Ireland and Spain and in office properties in Japan.

Marshall believes the current pricing is very attractive in the “quickly recovering” U.S. market, in which rents are starting to move up, and in the “hard-hit” European market, in which office buildings and shopping malls are available at a discounted rate. The Asian market, she adds, “has excellent exposure to growth.”

Warren suggests investing in Canada for yields and in the U.S. and Europe for growth. He believes European real estate will do well as it rebounds from crisis levels, followed by Asia, in the near term.

There’s general consensus, though, that investing in global real estate has many risks and challenges. Having local property managers on the ground who understand the nuances of their markets is a necessity in all instances, Marshall advises. Clients also must be aware that political, legal, regulatory, tax and currency risks, which vary among countries, can have an impact on their investments.

At an individual property level, portfolio managers consider factors such as current and expected income growth, risks related to income growth, duration of income, tenant default risk, liquidity risk and management costs to find the best properties to invest in.

At a more macro level, risks that portfolio managers consider include: choice of location to invest; level of concentration, including level of exposure to country, city or submarket categories; property-sector choice/concentration (whether investing in office, retail, industrial, residential or hotel); transparency relating to laws and regulations of ownership and operation; and quality and quantity of available information.

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