Foreign REITs Gain Flair

Cheaper than U.S. REITs, they also have strong growth potential.
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With valuations getting lofty for U.S. real estate investment trust stocks, now might be a particularly good time to spread your real estate bets internationally.

It used be the case that investing across several domestic REIT property types was an adequate way to get diversification. You could buy

Simon Property

(SPG) - Get Report

for mall exposure,

Vornado Realty Trust

(VNO) - Get Report

for office exposure and

Avalonbay

(AVB) - Get Report

for apartment exposure, for example.

Now, industry players advise on adding international real estate stocks to the mix.

Since 2002, non-U.S. real estate stocks have outperformed their domestic peers, says Amos Rogers, managing director of the Tuckerman Group, a real estate-focused investment management firm. That's saying a lot, since U.S. REITs have beaten the broader U.S. stock indices for this entire period.

For the first three quarters of this year, U.S. REITs returned 24%, while overseas real estate stocks returned 26%, Rogers says.

Bullish international investors believe this trend will continue, with the general thesis holding that there are more growth opportunities overseas. Moreover, valuations might be cheaper.

The mid-1990's boom that occurred with U.S. REIT stocks is now happening with international REITs, but even faster, says Steve Carroll, managing director with CBRE Global Real Estate Securities. Back in the '90s, U.S. real estate owners converted their properties into REITs to offer a tax-advantaged platform that also gave investors nice dividends.

Since 2000, seven countries have adopted REIT or REIT-like structures, including Japan, Singapore, France, and Hong Kong. Countries such as Australia and Canada already had the vehicles in existence. Next year, REITs will be introduced into the U.K. and Germany.

The fact that there are still so many REIT conversion opportunities is one major arena for potential growth, industry watchers say.

Stephen Coyle, chief investment strategist with Citigroup Property Investors, which manages money for institutional investors, says his firm is currently underweight U.S. REIT stocks because he believes they're expensive.

Private equity companies are paying big premiums to take U.S. REITs private, which has been part of the reason the stocks are priced so high. In contrast, in Japan (which approved REITs in 2000), a number of real estate operating companies continue to seed public REITs, Coyle says.

Nonetheless, the general strategy of going overseas is a good way to spread risk.

"We have found there's very strong diversification benefits going global with regards to REITs, rather than focusing on any one continent," Coyle says. The correlation between real estate stocks in the U.S. and Japan, for example, is just 7%, he says. Even between the U.S. and Europe, the correlation is 40%.

Those looking to invest in international real estate stocks currently must buy the stocks from brokers, oftentimes overseas (there are none on U.S. stock exchanges). There also are a host of mutual funds offering international real estate-focused products.

But in coming months, the first global real estate exchange-traded fund will be launched by State Street Global Advisors and the Tuckerman Group. The streetTracks International Real Estate ETF will invest solely in real estate stocks located outside the U.S. and will track the Dow Jones Wilshire ex-U.S. Real Estate Securities Index.

The ETF will be half REITs (which are required to pay dividends) and half real estate operating companies. The fund's geographic mix will be: Australia, at 19.6%; the U.K., 18.2%; Japan, 17.8%; and Canada, 8.1%, with other Asian and European countries making up the bulk of the product.

Barclays Global Investors also is rumored to be planning a global real estate ETF, but the company declined to comment for this story.

The global real estate stock market now has a market capitalization of $720 billion, with half of that in the U.S.

Much of the recent international real estate boom continues to be driven by institutional dollars. Countries like Japan and Australia have been heavily investing their citizens' retirement dollars outside their own countries for many years now. Recently, U.S. pension funds such as CalPERS have earmarked a large amount of money for overseas real estate investment.

In Asia, the story of the recent boom in real estate stocks is not just about institutional money, but also retail investors flocking to the sector, says Antony Green, an investment banker with Macquarie Bank of Australia.

"In Asia, there's a huge demographic change that's going on," Green told attendees of a panel discussion at the annual National Association of Real Estate Investment Trusts convention last week in San Francisco.

Aging populations and growing wealth are spurring demand for investments with yield, he said. As well, there's a particular amount of demand from wealthy individuals in Asia who were unable to invest in commercial properties until the REIT structure came along, he added.

Macquarie was involved with the first REIT IPOs in Singapore in 2002. At the time, the bank was trying to sell the stocks at an initial dividend yield of 8%. Now, these stocks trade at 5% yields, Green said.

This shows that cap rates, or initial rates of return on real estate, continue to fall globally, putting us all in a "low-return world," as many industry watchers like to say.

Of course, all this again raises the question of whether overseas real estate stocks are really that much cheaper, given that cap rates across the globe continue to compress.

"Nobody overseas is arguing that property-linked stocks are undervalued," says Barry Vinocur, founder and editor of REIT Zone Publications.

Nonetheless, "in the real estate investment space, (international) is the fastest-growing area," he says.