Investing in Bricks and Mortar Abroad
In the current challenging financial market environment characterized by uncertainty, low returns and zero or negative interest rates, investors are increasingly looking beyond traditional asset classes. Real estate is particularly in focus thanks to its robust income returns.
According to Preqin1, there were 492 private real estate funds in Q1 2016 – an all-time high. The growing interest in international real estate investments reflects the segment's ability to help investors meet their investment needs and goals.
The ongoing near zero-interest environment in most industrialized nations poses a variety of challenges to investors. Traditional fixed-income investments do not provide the yield levels they used to. On the other hand, an investment portfolio should also perform robustly in an environment with less ample monetary liquidity, notwithstanding the possibility that the current situation could prevail for some time.
In addition, demographics will have a significant impact on the Asset Management industry. As the median age increases, customers will demand more income-generating assets. A recent PwC survey of asset managers showed that low-risk yield products are the single most important product type2.
This is primarily because markets vary greatly from country to country and investors often know their own markets best. However, by investing in international real estate markets, investors can not only benefit from developments outside their home countries, but also diversify their portfolios and improve their risk-return profiles.
Benefits of Internationalization – Capturing Value Across Markets
Real estate markets differ significantly, for example in terms of transparency, taxation, but perhaps most importantly, they differ in where they stand in the real estate cycle. This means that successful investment and expansion abroad requires time, highly-specific expertise and a global platform. "Even in a country as small as Switzerland: if you're sitting in Zurich, it's not easy to invest in Geneva. You have to be informed about changes in regulation and taxation or zoning. If you then apply the same logic at the international level, differences are magnified by different local standards, cultures, legal frameworks and macroeconomic environments", says Ulrich Braun, Head Strategy and Advisory for Credit Suisse's Real Estate Investment Management.
Even in a country as small as Switzerland: if you're sitting in Zurich, it's not easy to invest in Geneva.
This has two consequences: On the one hand, real estate research is indispensable to investing internationally and becomes even more important when the scope broadens from a national to an international approach. On the other hand, it is also important to have experts on the ground, which is why fund managers work closely with local specialists.
There are a number of ways to invest in international real estate, ranging from directly or indirectly invested international real estate funds, REITS and real estate equities, through to customized real estate mandates or club structures.
Direct and Indirect Investment Funds
Direct funds invest directly in a broad spectrum of buildings, while indirect real estate funds are primarily invested in real estate funds and equities (listed companies that operate in the real estate sector). The range of direct international investment products spans from market-specific, such as Europe or US only, to globally diversified. Many of these products have a strong focus on yearly dividends. "Direct international funds allow investors to take advantage of the returns generated from different cycles and to benefit from gains made through international diversification," says Braun. The ideal investment period for these products is typically more than five years.
Like direct funds, indirect portfolios are diversified in terms of geography and types of properties, including office and retail as well as residential. Investors in indirect real estate funds benefit from the fact that they achieve broad-based diversification through one single investment. According to Christoph Bieri, Head of Credit Suisse Asset Management's Indirect Real Estate team, another benefit of indirect investing is the possibility of active management. If fund managers want to increase exposure in one market segment and decrease exposure in another, they can change the portfolio allocation more readily than other types of investment funds.
As Braun points out, investing in real estate funds could be seen as particularly attractive, as they can generate average annual income returns of around 3 percent. "Conventional investment strategies are generating about 1.8 percent for investors, so there is a very strong case for direct and indirect investments in real estate funds." However, these higher returns reflect higher risk levels that potential investors should take into account.
Liquidity, Interest Rates and Risks
One factor that investors should bear in mind when considering indirect real estate funds is liquidity, which according to Bieri is somewhat limited. In the case of listed target funds, daily liquidity is generally not a problem, but in the case of non-listed-funds, "investors can redeem their shares or invest only on a quarterly or sometimes semi-annual basis", he says. The investment horizon, like for direct investment funds, is five years and upwards.
According to Bieri, investors should also be aware of the potential impact of a rise in interest rates on real estate investments. "If interest rates remain low, this strategy will give you upside. But if they should rise rapidly, which is not our main scenario, real estate valuations would be at risk. That being said, our main scenario is a moderate economic recovery, which would go in hand with a very slow rise in interest rates. This would allow real estate managers to price this into the rents, compensating for the rise in capitalization rates."
An Attractive Potential Solution in a Challenging Market Environment
With increasingly negative bond yields and the longer-term demographic outlook that will continue to impact the asset management industry in the future comes a rising demand for income-generating assets. For investors who are comfortable with the potential risks, including foreign currency risks, real estate can be considered an attractive investment class thanks to its ability to provide capital appreciation and income returns. Among the options available in the asset class, both direct and indirect investments could provide effective solutions in terms of diversifying a portfolio and providing attractive returns.
 Preqin Q1 2016 Quarterly Update Real Estate
 PwC Asset Management 2020: A Brave New World 2014
 FTSE EPRA/NAREIT Monthly Statistical Bulletin December 2015