SUBPRIME WOES HAVE HIT U.S. real estate stocks hard in recent months. But some investors are continuing to generate strong returns in property by diversifying overseas.
The Alpine International Real Estate fund has more than 80 percent of its $2.3 billion in assets in foreign securities. “The economic picture of many regions is very compelling, where we find strong growth rates supported by secularly low interest rates,” says portfolio manager Samuel Lieber. The tailwind of a falling dollar doesn’t hurt either, he adds.
The fund was up 12.7 percent year-to-date at the end of September and boasted an annualized return of 32.7 percent over the past five years.
Lieber’s largest holding, representing 2.71 percent of assets, is Bermuda-based Orient-Express Hotels, which operates high-end hotels in vacation destinations from Charleston, South Carolina, to Venice to Bali. Its shares were up nearly 24 percent in dollar terms over the year through September 24, and up more than 46 percent annualized over the past three years. The fund has a comparable stake in Norwegian Property, which focuses on commercial holdings. The stock has surged nearly 48 percent since it was floated on Norway’s over-the-counter market in June 2006.
Foreign real estate stocks have strongly outperformed their U.S. counterparts this year. For the first nine months of 2007, U.S. real estate stocks, as measured by the S&P/Citigroup world property index, were down 4.40 percent; excluding U.S. stocks, the index was up 7.58 percent. A recent Morningstar survey found that every one of the 31 U.S. real estate mutual funds with more than 25 percent exposure to foreign markets outperformed the domestic benchmark by more than 500 basis points.
Moreover, the outperformance is not just a recent phenomenon. Total returns of many foreign real estate markets, in dollar terms, outpaced those of the U.S. over the ten years through 2006, says James Corl, CIO of Cohen & Steers real estate securities portfolios. Average annual returns were 24.6 percent for France, 18.2 percent for the U.K., 16.9 percent for the Netherlands, 15.6 percent for Switzerland and 15.0 percent for Australia, compared with 14.6 percent for the U.S.
Another benefit of foreign property is its limited correlation with stocks and bonds, which provides further diversification. According to Indraneel Karlekar, head of global research and strategy at ING Clarion Real Estate Securities, the S&P/Citigroup world property index was correlated 0.52 percent to the Standard & Poor’s 500 index, 0.59 percent to the MSCI world equity index and only 0.23 percent to the JPMorgan bond index.
Real estate performance varies substantially by national market, offering further diversification and reducing overall volatility. French real estate correlates 0.56 percent to U.S. real estate, 0.40 percent to both the U.K. and Australia and just 0.23 percent to Japan, according to the Cohen & Steers Global Educational Guide.
Meanwhile, the universe of international property assets is expanding rapidly because of securitization. In the 12 months ended in June, the proportion of securitized institutional-quality real estate grew from 7 to 11 percent of all global property values, amounting to $2.3 trillion, says Karlekar.
Many foreign markets also offer higher yields than the U.S. real estate investment trusts are paying out -- an average of 5.7 percent in Canada and 5.5 percent in Australia, compared with dividend yields of 3.7 percent in the U.S.
Uncertainty about the potential wider impact of the subprime crisis on U.S. property provides a fresh incentive to look overseas, says Christopher Reich, coportfolio manager of the ING Global Real Estate fund. U.S. REITs traded at a 17 percent discount to net asset value at the height of the crisis -- the largest discount seen in a decade. That gap narrowed to 10 percent last month.
With 60 percent of his fund’s $1.34 billion in assets invested overseas, Reich has been shielded from the fallout. In the 12 months ended September 30, the fund rose nearly 17 percent, largely because of its overweight exposure to Asia ex-Australia. “We are seeing the world’s strongest economic performance coming out of this region,” says Reich, “which should help sustain economic growth more so than in years past.”
Hong Kongbased developer Kerry Properties; Singapore’s CapitaLand; and Zhongshan, Chinabased Agile Property Holdings, which develops housing and commercial properties in China’s Pearl River delta, collectively represent 4 percent of the fund’s assets and have doubled in value on average over the past year.
