March 20, 2006 12:00 AM

Global moves cause anxiety

Investors face boatload of risks, but don’t see any other choice

Arleen Jacobius

Dennis Yeskey said institutional investors are going outside the United States in an effort to better diversify their real estate portfolios.

A growing number of U.S. institutional investors are spending more of their real estate allocations outside the United States, but worry that such investments are giant leaps of faith.

With returns on U.S. direct real estate and real estate investment trusts expected to dip, executives at pension plans, endowments and foundations are turning not just to Western Europe and Japan, but also to China, India, Russia and Latin America in general.

What concerns them are the risks: currency; foreign ownership; political; and liquidity. Some wonder whether they would reap better risk-adjusted returns by investing in certain domestic real estate sectors such as hotels and office buildings.

Dennis Yeskey, principal, Deloitte Financial Advisory Services LLP, New York, and leader of its real estate capital markets practice, said this is the third wave of overseas real estate investments. The primary reason this time is diversification. Today, many investors that first invested in emerging markets equities in such countries as India and China now are investing in real estate in the same countries in search of higher returns, he said.

But "there is still a lot of opportunity in the U.S.," Mr. Yeskey added. "There's more money in the U.S. value-added and opportunity funds" than in global real estate, he said.

He noted that even though U.S. investors worry that the high-flying domestic REIT market will go bust, they still maintain their U.S. REIT investments because they like the dividend flow and are hoping for a jump in returns from mergers and acquisitions in the REIT market.

Rise to $1 trillion

More than half of the $600 billion global REIT market is composed of non-U.S. real estate securities. That total is expected to balloon to $1 trillion by 2010, with only 30% U.S REITs, said J.D. Sitton, vice president and client portfolio manager for REITs at JPMorgan Asset Management, New York.

Since 2000, there's been a tremendous growth in the global REIT market, said Joe Azelby, managing director and global head of JPMorgan Asset Management's real estate business.

At the same time, 2005 was the first time there was a net shrinkage in the U.S. REIT market as more public REITs were taken private, Mr. Azelby said. "We expect more privatization of public REITs next year," he said.

Institutional investors with fully committed real estate allocations are moving or considering moving assets from domestic to global real estate and real estate securities. Those with room in their allocations already are investing in global vehicles.

Executives at the $11.5 billion Kansas Public Employees Retirement System, Topeka, are looking into global real estate securities; the system has invested in domestic REITs since 1997, said Robert Schau, real estate investment officer.

Speaking at the Pension Real Estate Association's spring conference in San Francisco earlier this month, Mr. Schau said U.S. investors have been reluctant to invest internationally until recently.

"The pendulum tends to overswing," he said. Already, a lot of capital is moving into foreign real estate, reducing expected returns, Mr. Schau noted.

Timing a big factor

In an interview, Mr. Shau said timing the entry into the global REIT market is a big factor. He had wanted to begin shifting some of the system's investments from domestic REITs into global securities six months ago.

Currently, the real estate portfolio constitutes 8% of plan assets; 42% of that portfolio is in domestic REITs, while the rest is in other real estate investments.

"We are not rushing in (to non-U.S. REITS) due to the current lack of liquidity," he said. "Now we will be looking at global real estate securities over the next year or year and a half."

Governments can stop money from moving out of their countries, and non-U.S. REIT markets are still much smaller than the U.S. REIT market, hindering liquidity of non-U.S. real estate securities, he said.

It's hard to measure the risk in emerging market real estate investments, said Bruce Cundick, chief investment officer of the $20.1 billion Utah Retirement Systems, Salt Lake City, at the PREA conference.

Despite those concerns, investors are committing capital to non-U.S. real estate strategies.

The Oregon Investment Council's board is considering shifting real estate assets into more global strategies, starting with REITs, said Kevin Max, spokesman for the council, which oversees the $48 billion Oregon Public Employees Retirement Fund, Salem.

The $205 billion California Public Employees' Retirement System, Sacramento, can now invest up to half of its $9.3 billion real estate portfolio abroad and up to 25% of the non-core portfolio can be invested in global REITs. (According to a new investment policy adopted Feb. 14, up to 70% of CalPERS' real estate allocation can be in non-core investments.)

CalPERS has 4.3% of assets in real estate, close to four percentage points lower than its 9% target allocation, because the system has been selling domestic real estate.

Investors are not only interested in investing in global real estate securities, they are making commitments to funds investing in global direct real estate as well.

Opportunity fund

On March 9, Morgan Stanley Real Estate announced the closing of a $4.2 billion opportunity real estate fund to invest in non-U.S. real estate. The fund attracted mostly U.S. pension fund investors, as well as institutional investors from Asia, Australia and the Middle East, said Jay Mantz, managing director and co-head of Morgan Stanley Real Estate, New York.

Morgan Stanley Real Estate Fund V International was above its original $3 billion target and close to double the $2.4 billion it raised in 2000 for Fund IV International, which had the same strategy.

Among the investors are the $53.7 billion Pennsylvania Public School Employees' Retirement System, Harrisburg, which committed $150 million, and the $5.1 billion San Bernardino County (Calif.) Employees' Retirement Association, which committed $25 million.

About 80% of the new fund will be invested in Western Europe and Japan, Mr. Mantz said.