The Case for Global Real Estate

by Anthony Davidow, CIMA®, Vice President, Alternative Beta and Asset Allocation Strategist, Schwab Center for Financial Research

Key Points

  • Global real estate investments offer the potential for growth—increasingly important as the economic activity of several emerging markets increases more rapidly than that of many developed markets.
  • Global real estate investments have historically delivered attractive returns and income relative to traditional investments.
  • They also perform differently than stocks and bonds during various market cycles, offering diversification benefits.
  • There are a number of ways to invest in real estate, including Real Estate Investment Trusts (REITs), Real Estate Operating Companies (REOCs), and mutual funds and ETFs that invest in them.

When investors think of real estate, they often think of their investment in the roof over their head or possibly a vacation property or a rental unit. But increasingly, investors are setting their sights a bit further afield with global real estate investments.

Why? Global real estate can be a valuable addition to an investment portfolio—complementing the traditional mix of stocks, bonds and other investment options. An asset with a low correlation to other investments in your portfolio can both reduce overall portfolio risk and increase returns. Global real estate offers the potential for growth and income, plus diversification for investors who have a tolerance for risk. Here, we’ll take a look at some of these features and discuss common ways to invest, such as through publicly traded Real Estate Investment Trusts (REITs) or Real Estate Operating Companies (REOCs), both of which are known as “real estate securities.” We’ll also discuss investing through mutual funds or exchange-traded funds (ETFs) that invest in real estate securities.

Capitalizing on global growth

In recent years, there’s been a shift in worldwide economic activity, as measured by gross domestic product, or GDP. While the United States boasts the world's largest economy and stock market, the country's share of the world’s GDP has been declining. Investing only in US stocks means excluding nearly three-fourths of the global economy1 and over half of the world's stock market value.2 Indeed, developed markets, like the United States and Europe, are contributing a smaller share of global GDP, compared to their historical average. Developed market economies accounted for 80% of global GDP in 2000, but only 61% by the end of 2013. In contrast, emerging market economies have grown from 20% of global GDP in 2000 to 39% in 2013.3

Forecasts call for GDP growth in emerging markets like Asia and Latin America to outpace gains in developed markets for years to come. If the balance of economic activity continues to migrate away from developed economies in the United States and Europe, real estate in developing markets can provide a way to tap into ascending economies. Real estate often serves as an effective barometer of economic health. Rising real estate prices and rents indicate strong demand and a healthy economy; conversely, falling real estate prices often portend trouble ahead.

There’s the potential to harness this global growth

Though past performance never serves as a guarantee of future results, as the graphic below shows, global real estate has performed favorably over time relative to a domestic benchmark (S&P 500® Index) and an international benchmark (MSCI EAFE Index). A $10,000 investment in the benchmark global real estate fund index (FTSE EPRA/NAREIT Global Index) in February 2005 would have grown to over $19,000 by June 2014—and that period includes the 2008-2009 financial crisis. Investing the same amount in US stocks—as measured by the S&P 500 Index—would have provided a slightly better return of $19,860. However, the same investment in international stocks, as measured by the MSCI EAFE Index, would have come up short at $17,570.4 Keep in mind that the FTSE EPRA/NAREIT Global Index also experienced greater volatility during this period.

Global real estate outpaces global securities

Global real estate outpaces global securities

Source: Morningstar Direct. Data as of 2/22/2005 to 6/30/2014. FTSE EPRA/NAREIT Global Index was incepted on 2/22/2005. Past performance is no guarantee of future results. The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product. Dividends and interest are assumed to have been reinvested. Indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested in directly.

Global real estate also has historically provided attractive yields relative to equities and many fixed income options. As of June 30, 2014, global REITs had an average yield of 3.53%, whereas the 10-year Treasury was yielding about 2.53%, and global bonds as represented by the Barclays Global Aggregate Bond Index ex U.S., was yielding only 1.45%. Note that when comparing the yield of global REITs to other fixed income and equity-dividend investments, be aware that global REITs tend to experience higher volatility and are more susceptible to rising interest rates.

Equity-dividend yields vs. fixed income yields

 

Global REITs 3.53% High-yield bonds 4.91%
US stocks 1.91% Corporates 2.91%
International stocks 3.37% Global bonds 1.45%
Master limited partnerships 5.11% Treasuries 2.53%

Source: Bloomberg. Data as of June 30, 2014. Asset classes are represented by the following indexes: Equities: Global Real Estate: FTSE EPRA/NAREIT Global Index; U.S. Stocks: S&P 500 Index; International Stocks: MSCI EAFE Index; Master Limited Partnerships (MLPs): Alerian MLP. Fixed Income: High Yield: Barclays U.S. Corporate High Yield Bond Index; Corporates: Barclays U.S. Corporate Bond Index; Global Bonds: Barclays Global Aggregate Bond Index ex-U.S.; Treasuries: U.S. Generic Gov’t 10 Year Yield, U.S.G 10YR Index.

A complement to stocks and bonds

As you can see in the graphic below, there’s a natural rotation amongst the best and worst performing asset classes. For example, in 2006, 2009 and 2012, global real estate performed better than stocks, bonds, and commodities; in 2007 and 2008, however, it performed the worst. While global real estate has historically provided attractive returns and income, it can experience greater variability in performance compared to traditional investments given its sensitivity to interest rates and potential country-specific risk. By allocating across multiple asset classes including global real estate, investors can gain diversified exposure that should help dampen volatility at the portfolio level.

The best and the worst performing market segments over time

The best and the worst performing market segments over time

Source: Morningstar Direct. Asset classes are represented by the following indexes: Broad U.S. Stock Market: S&P 500 Index; U.S. Small Cap Stocks: Russell 2000® Index; International Stocks: MSCI EAFE Index; Global Stocks: MSCI World Index; Investment Grade Bonds: Barclays U.S. Aggregate Bond Index; Commodities: Dow Jones–UBS Commodity Index; Global Real Estate: FTSE EPRA/NAREIT Global Index. Past performance is no guarantee of future results. Dividends and interest are assumed to have been reinvested. Indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested in directly.

Inflation hedge

Some investors turn to real estate as an investment because of its reputation as a hedge against inflation. When inflation rises, homes and commercial properties tend to climb in value commensurate with prices for food, energy and other goods. Real estate is viewed as a hedge because as inflation sets in, property owners may also have the ability to raise rental incomes. As a result, some now flock to real estate in times of anticipated inflation, viewing the tangible asset as a way to maintain the value of their wealth.

How can you invest?

Investors considering global real estate have four different options:

  • Direct overseas property investment. This could entail potential challenges such as hefty down payments, maintenance obligations and restrictive foreign ownership laws, not to mention the cost of traveling to check on the property.
  • Real estate investment trust (REITs). These corporations invest in real estate properties, mortgages or both. REITs are stocks that can be bought or sold on the major exchanges and have to distribute 90% of their income to shareholders as dividends. REITs have special tax considerations and typically offer investors high yields in addition to a liquid opportunity to invest in real estate. REITs also offer a variety of investing styles: Some invest in property in specific geographic regions, while others are widely diversified. Some REITs specialize in property types, such as office buildings, shopping malls, apartments, warehouses, hotels or a combination of properties. Note that too much concentration in any one property type can increase risk.
  • Real estate operating company (REOCs). These corporations are similar to REITs in that they own real estate and trade like a stock. However, REOCs don’t have to distribute their cash flow to investors, leaving them free to invest in their holdings in other properties or improvements.
  • Mutual funds or ETFs that invest in REITs or REOCs. As mutual funds and ETFs can invest in a number of securities, they can provide diversified exposure across a variety of sectors and regions.

Market-cap vs. fundamentally weighted funds

Most index funds are market-cap weighted, meaning that the largest company by market capitalization, or stock market value, is given the largest weight. Another way to tap into global real estate opportunities is through fundamental strategies, which employ a rules-based discipline in weighing securities based on factors such as sales, cash flow, dividends and buybacks.

This difference in weighting can have an impact on securities included in the fund. To see this impact, we compared the country allocations of a fundamentally weighted global real estate index, the Russell Fundamental Global Select Real Estate index, with a market-cap based index, the FTSE EPRA/NAREIT Global Index.

As you can see below, both indexes have a significant allocation to the US and Japan but there are subtle differences in allocations to some countries. For example, take Hong Kong: The market-cap index has a 7.48% allocation, while the fundamentally weighted index has almost a 10% allocation. For Australia, the market-cap index has a 5.97% allocation, while the fundamentally weighted index has a 9.31% allocation. As an investor, it’s important to be aware of these differences so your portfolio has the exposure that you are expecting.

Country allocations: Russell Fundamental Global Select Real Estate Index vs. FTSE EPRA/NAREIT Global Index

Country allocations: Russell Fundamental Global Select Real Estate Index vs. FTSE EPRA/NAREIT Global Index

Source: Morningstar Direct, Russell Indexes, and FTSE Indexes. Morningstar equity industry allocations. Data as of June 30, 2014.

Bottom line

Global real estate can be an attractive addition to an investment portfolio—complementing the traditional mix of stocks and bonds. It offers the potential for growth and income, plus diversification, but before investing in global real estate, it is important to understand the structure of the securities and the potential risks.

I hope this enhanced your understanding of global real estate. I welcome your feedback—clicking on the thumbs up or thumbs down icons at the bottom of the page will allow you to contribute your thoughts. (If you are logged into Schwab.com, you can include comments in the Editor’s Feedback box.)

Important Disclosures

Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

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