Investors are putting money into real estate companies outside the U.S. at a record pace as interest rates recede, economies expand and opportunities remain to buy assets at discounts amid lingering distress from the global financial crisis.
The SPDR Dow Jones International Real Estate Exchange– Traded Fund, the largest ETF for non-U.S. real estate, attracted net inflows of $304-million in August, the most of any property ETF, driving its shares outstanding – a proxy for demand – to a record, according to data compiled by Bloomberg. Last month's surge catapulted property ahead of energy for the first time in industry fund flows year to date, the data show. ETFs are passively managed funds that aim to replicate the performance of benchmark indexes for various industry groups.
Real estate has emerged as the asset of choice following the global financial meltdown because of its relatively high yields. While the U.S. has claimed a large share of interest for its perceived stability and enduring appeal of gateway markets such as New York and Los Angeles, investors also have increased purchases in Europe, Asia-Pacific and Latin America.
"Many investors that have moved to have real estate allocations in the U.S. are now looking to do so internationally," said David Mazza, head of ETF investment strategy at State Street Global Advisors. "Investors are looking ahead to greater cyclical recovery and taking advantage of some pockets of distress" outside the U.S.
Japan, U.K.
Japan has the largest weighting in the SPDR Dow Jones International Real Estate ETF, at 21 per cent, followed by the U.K. at 14.1 per cent, Australia at 13.6 per cent, Hong Kong at 10.5 per cent, Canada at 10 per cent, France at 9.2 per cent and Singapore at 7.7 per cent. The Netherlands, Switzerland and South Africa round out the top 10.
A Bloomberg index of U.S. real estate investment trusts fell 2.3 per cent in the fourth quarter amid concern the prolonged period of suppressed interest rates would cease, then rallied 21 per cent this year as the yield on the 10-year Treasury note fell to 2.3 per cent from 3 per cent at the end of 2013. That meant borrowing costs would stay low for the time being.
Whether it's private-equity firms and foreign pensions flush with cash chasing commercial and housing distress in Europe and Australia and economic growth in South America, or Russian billionaires and wealthy Chinese buying homes in London, Canada and the U.S., cross-border real estate flows are increasing.
GIC, Manulife Singapore's GIC Pte Ltd., barred from investing in Singapore itself, bought a half stake in London's Broadgate office complex last year for more than 1.7 billion pounds ($2.8-billion), a record for a central London property.
In June, Citigroup Inc. paid a record HK$5.4-billion ($697-million) for a Hong Kong office tower that will bring most of its 5,000 employees under one roof. Canada's Manulife Financial Corp. last year paid HK$4.5-billion for a similar-size tower and development in the city's Kowloon district.
"Canadians are buying everywhere," said Ross Moore, director of Canada research at CBRE Group Inc., the biggest commercial broker. "They are shopping the world. What's happened in the last five to 10 years is the big pension funds pretty well own everything of quality in Canada. They love real estate and have all this money coming in and they have to put it somewhere."
Toronto-based Brookfield Asset Management Inc. has started investing in European warehouse properties and Indian offices after accumulating the biggest holdings of office buildings in both the U.S. and Canada. The real estate unit of Ontario Teachers' Pension Plan has been investing in Brazil as well as the U.K. and Australia. Canadian Pension Plan Investment Board has bought London residential, retail and office properties.
Easy targets
Markets such as the U.K. and Australia are easy targets for North American investors, Moore said.
"The ownership structures are familiar, the legal structures are very similar, they understand what they're getting into and the transparency is good," he said.
In Japan, where interest rates are near zero thanks to central bank stimulus, investors can borrow cheaply to buy buildings whose rents translate into an investment yield that's three or more percentage points higher, said Sonny Kalsi, co– founder of GreenOak Real Estate, who previously led Morgan Stanley's real estate investment unit.
Investment yields on properties are measured in terms of capitalization rate, a building's net operating income divided by purchase price. A property valued at $100-million with income of $5-million a year would translate to a cap rate of 5 per cent.
Liquidity, stability
"Liquidity, stability and the view that rents have a lot of upside" are driving real estate investment in Japan, said Kalsi. "You can buy for a 4 to 6 per cent cap rate, and borrow at 1 to 2 per cent so there's significant positive spread with real potential upside."
By company, the international property ETF's biggest holdings are Mitsui Fudosan Co., Japan's second-largest developer; Brookfield Asset Management; Paris-based Unibail– Rodamco SE, the biggest developer in Europe; Scentre Group, the Westfield Group spinoff that owns shopping malls in Australia and New Zealand; and Land Securities Group Plc, the largest developer in the U.K.
ETF Gains
The SPDR International Real Estate ETF had a record 117.8 million shares outstanding as of Aug. 29 – a proxy for fund flows since more shares are created to meet demand – up from 400,000 shares when the fund was formed in December 2006. The ETF has gained 10.3 per cent year to date with dividends reinvested, compared with 9.8 per cent for the Standard & Poor's 500 Index, the U.S. equity benchmark gauge.
Also paving the way for more real estate deals are the early stages of a rebound in the commercial mortgage-backed securities market in Europe and new REIT legislation in India.
Some investors say the heightened liquidity is a warning sign. Hyper-liquidity in 2007 was a prelude to the real estate crash, as the flood of debt made available through the CMBS market encouraged borrowers to pay ever higher prices.
Additionally, overbuilding in China on the residential and commercial side have kept some investors wary of putting money in Chinese properties.
"Asia's tough," said Moore. "You think everybody should go there but that's also where a lot of the construction is occurring. No sooner do you buy something than a new building competing for your tenants goes up."
Real estate companies' earnings are rising faster than interest rates and as long as that remains the case, demand and asset values will likely hold up, said State Street's Mazza.
"If we get to a place where leverage because of the excess liquidity is increasing faster than revenue growth and earnings, that is a sign there is some overheating," he said. "We don't see that at present."
