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© 2014 OnCourse Learning. All Rights Reserved. 1
Chapter 24
International Real Estate Investments:
Markets, Strategies and Implementation
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Structure of Chapter 24
24.1 There’s a Big World Out There24.2 Going International: Rationales and Obstacles24.3 Developing and Implementing International Real
Estate Strategies24.4 Chapter Summary
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Learning Objectives
Rationales of international real estate investmentObstacles and disadvantages associated with
international real estate investmentConsiderations driving international institutional real
estate portfoliosInstitutions enabling successful international real
estate investmentInternational real estate portfolio management
strategies
3
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24.1 There’s a big world out there
24.1.1 The global RE capital market: size and flowsEstimates of international real estate capital market size
and flowsImportant global developments in securitization
24.1.2 The institutions of globalizationThe international RE systemInstitutions of International Transparency
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24.1.1 The global real estate capital market: size and flows
Real estate investments have traditionally been very local, but the international real estate capital market is well-developed
Estimates of international real estate capital marketThe estimated global institutional market in 2004 was US$
7.7 trillionEuropean and Asia-Pacific markets are big and growing
(see charts)Especially Asian market is small compared to its potential
Markets very small relative to population and expected GDP growth
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Size and composition of the European real estate market
The capital composition of Europe’s invested stock has been stable.
Public capital sources are far less important than in U.S.
Source: DTZ Research
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Size and composition of the Asia-Pacific real estate market
Continuous growth in invested capital stock in real estate
Public capital sources even less developed than in Europe
Source: DTZ Research
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24.1.2 The institutions of globalization: the global market is increasingly transparent
Relevant property market knowledge remains largely local in nature
Industry associations and for-profit firms (research consultants, data providers, property brokers) increasingly supply local data, of ever-improving quality
This development mainly holds for mature markets, with comparable returns
For many interesting emerging markets, transparency remains a problem
JLL transparency indicator reports generally increasing transparency, but the crisis has dented this upward trend.
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International real estate system becomes more and more public: global property share market at pre-crisis level
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-00
200
400
600
800
1,000
1,200
1,400
Asia Pacific
Europe
Americas
Africa
Source: GPR
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24.1 There’s a Big World Out There24.2 Going International: Rationales and Obstacles24.3 Developing and Implementing International Real
Estate Strategies24.4 Chapter Summary
Structure of Chapter 24
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24.2 Section introduction: Is international property investment a good idea?
Yes, let’s go international 1. There may be good investment opportunities outside of the home
country, especially if the home country has a well-developed property market: for opportunistic investors, the good times have passed.
2. It provides diversification benefits because markets move out of sync3. Export your superior portfolio management and/or development
expertise to other markets, and use your global client networkNo, better stick to one country4. International investment entails information costs: what do you really
know about foreign markets; will you have access to the best deals?5. How about transaction costs?6. Additional risks:
Political risk Economic risk Currency risk
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24.2.1 A first rationale for going international: return opportunities
Return opportunities abroad Can be of a structural nature …
Economic development Demographics
… or of a cyclical natureHome country may be at or over top of cycle, so invest in
countries where cycle phase is more favorableHowever, …. is timing really possible, especially in far-away
markets?And how about transaction costs?
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Economic growth is not evenly spread across the globe, and the differences are partly of a structural natureAs economic growth in mature markets (US, ‘old’ Europe,
Japan) is weak, so is growth in property demandEuro-area GDP growth since 1995: less than 0.5%United States GDP growth since 1995: 2.4%
Emerging markets (in Asia, ‘new’ Europe, Americas) have much higher economic growth and comparable demand for real estateChina: 9% in last two decadesIndia: 8% in last decadeCentral Europe: average of 3% since 1999Brazil: 3% since 1999
Structural return opportunities abroad: economic development
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Economic growth goes hand in hand with a growing need for property
Emerging economies need new and better housing, and they can afford it(Urban) housing to accommodate rapid urbanization, Ever higher-quality housing to accommodate wealthier demand
These economies need office and industrial properties to accommodate the workersEmployment is created in industry and (subsequently) in
services Workers migrate from agriculture to industry and (later) to
servicesThese societies are getting the spending patterns of the
WestNeed shopping centersLeisure projects
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These property needs translate into large structural capital needs
Mature markets have mature capital markets, with lots of institutional investors and a structural oversupply of capitalNothing new about that: in 18th century, the Dutch
financed the American economyBut since the global crisis, capital seems to flow from
emerging economies to mature markets (mirroring their current account surplus)
At some point, these capital flows will be again from mature markets to economically emerging markets
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Structural return opportunities abroad: demographics
The demographic tide differs strongly across countriesPopulation is some countries keeps on growing, while it is
already shrinking in othersIt also differs greatly by property type
Demand for office space depends on working populationDemand for retail space depends on total population,
population composition, and purchasing powerDemand for housing depends on household formation
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Demographic changes and the office property markets
Demand for office space is driven by employment …… but only if there are people to take the jobsState-of-the-art predictive models of office markets
assume all employment growth leads to occupied jobs, and occupied jobs need workspace
If employment growth is not matched by growth in labor population, labor force growth becomes driver of demand for office space
What will future office demand look like?How will that affect the office markets?
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Take a look at the literature regarding demographic effects on the property markets Mankiw and Weil (1989)
House prices will fall when baby boom ends Hendershott (1991), Dipasquale and Wheaton (1994), Engelhardt and
Poterba (1991), Holland (1991), market since 1989 The Mankiw and Weil critique: supply may react adequately But in United States demand growth is only slowing down, not getting negative
State-of-the-art predictive models of office markets assume all employment growth leads to occupied jobs, and occupied jobs need workspace
If employment growth is not matched by growth in labor population, labor force growth becomes driver of demand for office space
But this problem is too big to ignore Can supply react adequately if demand growth is negative?
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Population aged 18-65, 1960-2060No more growth in Europe, but America and Far East zoom on
Source: United Nations
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Population aged 18-65, 1960-2060 Is shrinking in some countries and grows less in others
Source: United Nations World Population Prospects Database.
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Population aged 18-65, 1960-2060 Emerging countries also show mixed demographic picture
Source: United Nations World Population Prospects Database.
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Female economic participation level is near limit in mature economies and shows harmonization at 45%-46%
0%
10%
20%
30%
40%
50%
1950
1960
1970
1980
1990
2000
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So will a gloomy future for the (European) office markets be inevitable?
The labor force in services may growEU enlargement will cause immigrationLater retirement and net inflow from disabled and unemployedMore women
Migration within countries makes picture more complicatedAttractive cities and regions will attract labor force; more
competition between cities and locationsEven if all this will happen, office demand will grow less
Either new supply will have to slow down, or prices will fallChange surely felt by developers; probably by investors
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Demographic changes and the retail property market
Macro-demand for retail space is driven by number of people and their purchasing powerNumber of people and age composition determines
quantityPurchasing power determines quantity and quality
Net new space only needed if these variables grow, otherwise only replacement
Type and location of needed retail space, and success of retail formats partly driven by composition of population
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European population, 1950-2050Population is already shrinking
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Tho
usan
ds
0 - 19 20 - 64 65 +
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Expected growth in wealth and population maintain attractiveness of retail in next decadeHow certain are these developments?
How about migration?Population growth may be boosted by EU enlargement
and migration flows Eastern EuropeProbably most relevant for the larger EU countries …… but these people do not yet have a lot of purchasing power
Strong regional differences, so inter-country migration also very relevant for retail property
Other intrusions in the demographic pictureFertility rate may pick up and mortality rate may go downWill the economic climate be favorable?
Yes, projections of real growth based on extrapolation 1974 suggest lots of growth is possible
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Demographic changes and the housing markets
Demand for housing units is driven by income development and interest rate, but ultimately by household formationHousehold formation determines quantitative demandIncome and interest rate determine qualitative demand
End of baby boom has led US researchers to predict deep bust on housing market
Subsequent research and market developments have shown that housing supply has adequately adjusted for lower growth in demand …
… but research concerns United States, where number of households keeps growing stronger than in Europe and many other regions
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Number of households in Europe, 1950-2050Falling from 2015 onwards; less than 10 mln to go before that
0
25
50
75
100
125
150
175
200
225
250
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Source: Brounen and Eichholtz, 2004
millions
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European housing demand will grow for another decade, but regional differences are largeAre these development inevitable?Again, migration may change the picture
EU enlargement, Eastern Europe and Mediterranean migration flows could mean new structural demand for (cheap) housing
Inter country migration will still be very importantExceptions
Turkey not only has growing population, but also shrinking family sizeMore demand for housing in urban areas, less in rural ones
If housing will be replacement market instead of growth market: supply should adjust, or prices will go downdevelop for more wealthy demand (incomes keep rising)prepare for more competition; quality is key
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Summing up the demographic developments
Property markets in many countries are turning into replacement marketsGood quality will drive out bad qualityCompetition between regions will increaseSupply will have to adjust to avert prices falling
Fundamental uncertainty in these property markets is increasing
Market effects first felt in development and construction market
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Consequences for international property investment
Different property types are exposed to different aspects of the demographic tideDemographic changes will first affect office market, then retail
and housing marketsEurope and Japan are ahead on the demographic curve
Emerging economies in Europe are very mature demographically
Immigration-based countries will follow (much) laterSo investors from demographically mature markets
make and should make strategic allocations abroad, especially to demographically immature markets
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Cyclical return opportunities abroad
They really existReal estate markets move in non-synchronous waysLook at DTZ, JLL, CBRE overview of property cycles
At any moment in time, for any property type, a global snapshot of local markets shows that there is a market in any phase of the cycle
International real estate investment enables timing approach without the need to go into cashIf all property market segments in home country are expected
to do poorly, a local market timer has to go into cashThere will always be other countries in which expectations are
more favorable, and they can be investment target
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Cyclical return opportunities abroad: yes, but
To put these cyclical movements into practical investment policies, they need to be predictableAre they? Key and Marcato (2005) suggest they are, but this
is research for one country, without international dimension Property is illiquid and trading is expensive
Markets move in cycles, but is international timing possible?Success of opportunistic property funds would suggest it:
they grow and are very popularCan somebody from far away truly predict a market? Why
would a local player who can really predict the market share that information with you?
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24.2.2 A second rationale for going International: diversification
Intuition, logical reasoning and a short look at the fundamentals
Theoretical underpinningsGlobal efficient frontier versus national frontierDownward shift of market riskThe International CAPM
What does the empirical evidence say about this?The case for international diversification
reconsidered
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Is international diversification a good idea for property investors?
International differences in market performance (economic, demographic, property) may be non-predictable, but you can still use them through diversification
Intuition and straight economic reasoning would suggest this is a good ideaDiversification is creating exposure to different aspects of the economyEconomies differ across countries
Timing of business cycles out of syncCountries have different economic bases (concept of regional economic base on an
international level)Property markets driven by local factors en local economies
Demand is local employment, consumer spending and housing demandDemand is local demographics ( we just saw how they differ)Cash flows and their volatility are driven by local market institutions (rental contracts,
zoning rules, etcetera)Supply partly driven by local circumstances, like capital availability
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Big international differences in rental contracts provide diversification benefits through different cash flow streams and risk exposures Exhibit 24.8
Country Lease length Rigth to Renew Period Basis Period BasisAsia-Pacific
Australia Indef./3-10 years Varies Varies Varies Annual COLChina 2-3 Years Yes Expiry Market N/A N/A
Hong Kong 2-6 Years No 2-3 Years Market N/A N/AIndia 3-9 Years Yes 3 Years Market N/A N/AJapan 2-5 Years Varies 6 month prior to lease exp. Vaires N/A N/AKorea 1-2 Years Yes 1-3 Years Market N/A N/A
Singapore 2-3 Years Yes 2-3 Years Market N/A N/A
AmericasArgentina 3/5/7/10 Years Not Guaranteed 2-3 Years CPI Anuual CPI
Brazil 3 Years Negotiable End of Term Market Annual CPICanada 1/3/5 Years Negotiable End of Term Market Annual CPI or spec amtMexico 3-10 Years Negotiable Annual CPI Annual CPI
U.S. 3-5 Years Negotiable N/A Market Annual CPI or spec amt
Europe France 3/6/9 Years Yes Expiry Market 3 times/year or Annual Construction Cost
Germany 5-10 Years No Varies CPI Annual CPINetherlands 5-10 Years Yes 5-10 Years Market Annual COL
Poland 3-7; 10 max Years Yes N/A N/A Annual CPIRussia 3-5 Years No 6 months - 1 Year Varies N/A VariesSpain 1-25 Years Yes Negotiable Market Annual Col (ipc)
Turkey 1-5 Years No N/A N/A Annual CPIUnited Kingdom Up to 25 Years Yes 5 Years Market (upwards only) N/A N/A
Indexation BasisRent Reviews
Source: NAIdirect.com
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Business cycles are non-synchronous
International correlations in GDP growth are low
Panel A: Correlation Matrix Real GDP % Change
Argentina Australia Brazil India Turkey Indonesia China Eurozone Japan
Australia -0,28
Brazil 0,33 0,23
India 0,13 0,24 0,09
Turkey 0,29 -0,01 0,22 0,10
Indonesia 0,05 -0,34 0,18 -0,06 0,19
China 0,55 0,23 0,45 0,22 0,14 0,11
Eurozone -0,09 0,20 0,07 -0,11 0,27 0,01 -0,10
Japan -0,05 0,12 0,10 -0,07 0,41 0,43 -0,04 0,74
US -0,02 0,62 0,17 0,02 0,32 -0,20 0,10 0,70 0,53
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Theoretical underpinning:Global efficient frontier dominates national frontier through greater investment universe
Risk (σ)
Exp
ecte
d r
etu
rn
Domesticefficientportfolio
More return
Global efficientfrontier
Domesticefficientfrontier
A
C
Less risk
B
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Theoretical underpinning:Downward shift of market risk through increased universe of assets
Number of assets (#)
Ris
k (
σ)
Domestic portfolio
Global portfolioDomestic market risk
Global market risk
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Theoretical underpinning:The International Asset Pricing Model (IAPM)
Theoretical difference between country and the world is in currency effects
Under certain assumptions …PPP holds, international similarity in consumption baskets
… will IAPM derive similar portfolio advice to single-country CAPMInvestors should hold portfolio of risk-free bonds in own
currency combined with world market portfolioGlobal beta is single systematic risk measure
But IAPM does not explain international returns differences very well, so model should be extended to include more risk measures
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The evidence regarding international diversification: Mostly supportive
Supporting
Eichholtz (1996) Eicholtz (1997) & Eichholtz,
Huisman, Koedijk, Schuin (1998) Conover, Friday & Sirmans (2002) Hoesli, Lekander, & Witkiewicz
(2003) De Wit (2010) Kroencke & Shindler (2012) Literature Review: Sirmans and
Worzala (2003)
Not Supporting or Qualified Support
Liu and Mei (1998) Goetzmann and Wachter
(2002) Ling and Naranjo (2002) Stevenson (2000) found that
international RE stocks did not enhance a portfolio’s return or risk attributes.
Yunus (2009) finds increasing integration
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The case for international diversification reconsidered
Diversification effect depends on correlations between international RE marketsHow stable are these correlations?
Not stable at all, move over even short horizonsStructural shifts in correlation patterns
Globalization, international capital market integration lead to upward shift in correlations
Continental factors increase correlations, but only within economic blocks
Is the low correlation there when you need it?International correlations tend to shift upward in times of crisisThis holds also for real estate but less than for stocks and bonds
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24.2.3 A third rationale for going international: managerial considerations
Exporting know-howDecades of experience in institutional property portfolio
management and development may be used profitably in markets where such expertise seems to be lacking
Central and Eastern Europe?Emerging markets?
But how valuable is general know-how in property investment?Listed property companies trade at discounts to Net Asset Value (NAV)
for long periods, so consistent management premium is doubtfulKnow-how is probably more valuable in development
Pure development companies are traded at value of current portfolio (small) plus present value of development profits (big). This suggests consistent management premium, but even that is doubtful. Recent research suggests that only land contracts have value in development
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Other managerial considerations: servicing international clients
Corporate real estate users are becoming global …Coca Cola, Nestle, BP, Unilever, etcetera
… and so are their servicersBanks, law firms, accountancy firms, consultants
The providers of space are among those servicers. Do they have to become global, too?
Only when corporations prefer centralized purchasing of space, Only in sectors where corporations are indeed globalizingProbably depends on property type
Logistics: yes on both countsRetail: increasingly so, but truly global chains do not yet existOffices: global clients exist, but do not seem to centralize space decisionsResidential: no on both counts
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24.2.4 Obstacles to international property investmentCosts
Transaction costs are often higher abroadInformation costs are high and a fundamental obstacle to far-away
investorsLiquidity
Difficult to get into booming market at good pricesDifficult to get rid of property when markets turn bad
RisksCurrency riskEconomic riskPolitical risk
RegulationForeign ownership constraints, especially for real estateBarriers to repatriation of foreign-earned returns
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Costs:Transaction costs vary strongly across countries, and are usually higher than in the United States, especially the property transfer tax
Country Transfer Tax Agent's Fees Legal Fees(Pacific) Asia
Australia Sliding scale 2.0%-3.0% Varies
China 1.5% 1.0%-1.5% Varies
Hong Kong 0.01%-3.8% 1.0%Both B/S Varies
Korea 5.8%PBS VariesPBB 1.0%-2.0% Varies
Singapore 3.0% minus S$5,400PBB 1.0%-2.0%PBS/B Varies
Americas
Argentina 2.5% 5.0%50/50 By agreement
Mexico City 5.5% 5.0% By agreement
Europe
France 4.9% 1.0%-4.0% 0.9%-1.5%
Germany 3.5% 1.0%-6.0% 0.2%-1.5%
Netherlands 6.0% 1.3%-2.0% 0.3%-0.5%
Spain 7.0% 2.0%-5.0% By agreement
4.0% 1.0% 0.50%
2.0% 1.0%-4.0%
1.0%-7.0% VariesCanada
Poland
United Kingdom
By agreement
Japan 0.0% 2.0%-3.0% Varies
Source: NAI Global
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Costs: Information costs are important in private marketsTwo studies with international evidence: Eichholtz,
Schweitzer, Koedijk (2001), Eichholtz, Gugler, Kok (2011) Property market is not efficient
Possible to beat the market consistentlyPossible to be beaten by the market consistently
Who beats whom?The local property investors are the insidersThe international property investors are outsiders
This should be reflected in performance
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Measuring pure information costs:Split allocation effect from information effect
Procedure in 5 steps1. Look at country allocation for each international property
company for every year2. Construct mimicking portfolio of domestic property
companies with same country allocation as international company
3. Calculate return index for each mimicking portfolio4. Aggregate mimicking indices for each individual company
into one overall index5. Compare performance overall mimicking index with
performance index internationals
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Information costs are important …
0
100
200
300
400
500
600
1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
International property companies underperform an equally weighted index of national players by 2.7% per year
Customized Index Internationals
Source: Eichholtz, Koedijk and Schweitzer (2001)
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Political RisksBigger for real estate than for any other asset (maybe
except art), and especially for foreign investorsReal estate and land is part of the national heritageGovernment involvement (zoning, tenant protection) big
and structuralForeign investors are more vulnerable:
Weak political clout, especially without local coalition partners (if few jobs are at stake, for example)
Weaker connections at city hallUnfair laws and corruptionLow liquidity of directly held RE assets makes
expected political risk hard to escape
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RegulationThere may be impediments to foreign asset
ownership. If present, they usually are in place for real estate, and especially for housing and landSwitzerland is classical exampleFormer central/eastern EuropeChina
There may be impediments to repatriation of profits. More important for foreign direct investments, including direct real estate
These issues are gradually getting less important, especially within trading blocks
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Structure of Chapter 24
24.1 There’s a Big World Out There24.2 Going International: Rationales and Obstacles24.3 Developing and Implementing International Real
Estate Strategies24.4 Chapter Summary
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How to do it?
Given obstacles to international investment, how can an investor get a satisfactory performance?
A successful international property strategy takes advantage of the benefits, while avoiding the (most important) obstaclesLook at obstacles: which are more cumbersome for
international players than for domestic ones?Information costsPolitical risk
So how do you manage these issues?
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Implementation of an international RE strategy
Towards a global REIT marketDetermining country allocationPeer group benchmarking: what have the top
performers in international real estate investment done?
Currency hedging: do’s and don’ts
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Towards a global REIT market
Listed property companies enable uninformed investors to make well-informed foreign property betsPublic markets are more or less fairly priced, so buying listed
property shares in Hong Kong, Australia, France or the United States can be done by uninformed investors
Tax-exempt structures are now getting commonplace across the world. Slightly more than half of the property company universe is tax-transparent – 2004 (Op ‘t Veld 2005)
Most of these companies (a steady 90%) only invest in their own country, so are more or less local specialists
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How can the global REIT market help the global property investor? A look at the obstacles to international RE investment Costs
Transaction for property shares are low, and getting lower. Property share market is more or less informationally efficient, so information
costs are low or non-existent Monitoring costs and impediments: monitoring a foreign property share
portfolio is easy, and you can free-ride on the local co-shareholders Liquidity
Is better than direct property holdings, comparable to comparable shares and generally going up.
No discrimination going in or out Risks
Currency risk Economic risk: as big as for direct investments, but more liquidity Political risk: as big as for direct investments, but more liquidity
Regulation Foreign ownership constraints usually smaller for stocks than for real estate Barriers to repatriation of foreign-earned returns usually small for stocks
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Determining country allocation
Modern portfolio theoryLots of practical problems, period-specific outcomes and
corner solutions (put everything in market that happens to do well in sample period)
Using international index weightsStable allocation, but liable to ‘information coincidence’:
Australia happens to have highly securitized property market and is therefore over-weighted in global portfolio
Index weights with GDP adjustmentsStable allocation, closer to ‘true’ global property market
weights
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The “home market” concept
If direct property markets are inefficient, an investor should concentrate on market(s) in which he has an information advantage: the home market(s)Can be defined regionally or in terms of property type
Industrial properties in Northern EuropeRegional malls in North AmericaOffices in East Asia
Yes, but how about diversification?
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Intermediate investors and end investors
Intermediate investors (property companies)Shareholders can diversify, so diversification does not add valueGo for outperformanceFocus on the home martket
End investors (pension funds, family trusts, private persons)Find optimum on trade-off between diversification and
outperformanceTry to get critical mass in home markets, and use listed property
shares in all other marketsOr concentrate property holdings only in home markets and
invest in common stocks and bonds in all other markets
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24.1 There’s a Big World Out There24.2 Going International: Rationales and Obstacles24.3 Developing and Implementing International Real
Estate Strategies24.4 Chapter Summary
Structure of Chapter 24
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24.4 Chapter Summary
Return opportunities, diversification and managerial considerations provide strong arguments to invest internationally in real estate
But look out for political risks, illiquidity and especially information costs
Avoid these obstacles by concentrating private real estate holdings on home markets, while using global (property) share market anywhere else
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