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Global real estate, a world of relative value: Target markets 2019

Growing investor interest in diversification has increased demand for global core real estate. Making sense of the global opportunity set requires a structured and disciplined approach to regional market and sector selection. We present our target market analysis approach and discuss the practical challenges facing investors, including structuring, trade-offs between regional and global exposures, and
foreign exchange risks.

Capital at risk. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

Why go global?

The idiosyncratic nature of local markets, with their different fundamental drivers, means that investors may seek international real estate for beta exposure as well as for “alpha” generation via active regional, sector or asset selection. Today, the impetus for geographical diversification across Europe, the U.S. and Asia is reinforced by the pressure on performance as the cycle matures. In a lower-return climate, investors can be forced to choose between pursuing sustained performance by incurring a higher level of risk and moderating return expectations in favor of maintaining a constant risk profile.

One of the most compelling arguments in support of international investment comes from the continuing evidence on comparatively low correlation between geographies, 0.4 on average (MSCI Indices from 2007 to 2018 for China, Swiz, NL, UK, Fr, Ger, Jpn, Can, USA, Aus, HK, It, Sing, Spain.). The property markets of different countries exhibit considerably lower linkage than the equivalent equity or fixed income indices since they tend to be on different supply cycles. The chart below shows how this could potentially benefit a hypothetical U.S.-based investor.

Real estate is inherently local: there is a relatively strong correlation between economic growth and the performance of real estate markets. The interaction between regional GDP growth, credit cycles and interest rate cycles are important; negative impacts can be mitigated by combining regions and countries whose rates are less synchronized.

A smoother ride: Hypothetical returns from regional and global portfolios

real estate portfolio returns report

Source: MSCI, BlackRock (July 2019). Regional portfolio represents the investment universe as reported by MSCI IPD. Calculations are based on the full data set where there is a common historical span (2006-18). The figures relate to past performance. Past performance is not a reliable indicator of current or future results. The above does not represent a BlackRock product and is for illustrative purposes only.

A far-flung opportunity set

The greater opportunity set offered by global real estate investing is a double-edged sword. Breadth is a significant potential advantage. Yet the wider investment universe creates a new challenge: more deals to sift through across the Americas, Europe and Asia Pacific regions.

A consistent method of assessment at the city/sector level can help to narrow down the markets on which to focus, such that investment teams direct more time and energy towards markets that are likely to have more attractive opportunities. A framework can be also used in hold-sell analysis by portfolio managers. It can influence bidding and pricing: one may well display greater conviction when bidding within a high return/low risk market. The detailed data within such analysis can also guide underwriting assumptions.

Taking a higher-level view, such frameworks can also inform the challenging task of overall portfolio construction and the allocation of the top-down risk budget. Portfolio construction becomes even more challenging during periods of significant structural change, where future risks may look very different to historical risks. It is not always valid to assume that real estate markets will be mean-reverting.

Using our target market analysis framework, we offer our current global picks

real estate report table

Source: BlackRock Real Assets Research, August 2019. Subject to Change.

Implementation considerations

Several larger asset owners access real estate directly rather than through external managers. This approach can provide greater control over assets and could avoid manager fees and improve alignment of interest. However, these benefits come at a cost: internal management requires a substantial team with appropriate expertise, offices and resources on the ground in relevant regions, and somewhat less flexibility to enter and exit markets once teams have been built.

Irrespective of the route to market, boots on the ground are vital in sourcing, scrutinizing deals and managing asset-level risk in real estate. This can be done through team members in the relevant regions or by collaboration with appropriate local partners.

Global geographical diversification can potentially mitigate portfolio risk, however non-domestic real estate investing is likely to create additional risk management and implementation challenges.

Foreign exchange risks can turn very good investments into very bad ones. Industry advice with respect to currency risk management varies significantly, from full hedging and complex currency overlays or partial hedging (such as equity only) through to full exposure or no hedging. The optimal strategy will largely depend on investor’s objectives, hedging costs, investor domicile, tolerance to risk and organizational capabilities with respect to currency management. There is no single solution.

Similarly, portfolio and deal structuring can represent a “make or break” factor irrespective of the quality of the underlying real estate. This becomes significantly more complex in an international context. Portfolio structuring can also have implications for the tax that will be applied to non-domestic investors, representing a major source of potential leakage.

Key takeaways

  • Global diversification helps to mitigate volatility and can improve portfolio resilience. An international approach can also enhance opportunities for alpha generation.
  • A robust framework for comparing risk and return expectations across different geographies can help investors to focus on more attractive markets, allocate risk budgets, improve diversification and scrutinize asset managers.
  • Such frameworks should not be treated as screens: Real estate performance is idiosyncratic, and investors should remain open to a good deal in a less attractive market.
  • An investor seeking to take a global approach can opt to use global real estate managers, regional real estate managers or direct investment across appropriate risk profiles.
  • There continues to be a relative shortage of “global core” real estate funds.
  • Risks around structuring and currency management can turn good investments into bad ones.
Alan Synnott
Managing Director, Global Head of Research & Strategy for BlackRock Real Assets
Alan Synnott is the Global Head of Research & Strategy for BlackRock Real Assets.
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Simon Durkin
Director, European Real Assets Research
Simon Durkin is the Head of European Real Assets Research at BlackRock.
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Steve Cornet
Director, Head of US Research and Strategy for BlackRock Real Estate
Steven Cornet is a member of the Global Real Estate Research & Risk Analytics team.
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Bruce Wan
Director, Head of APAC Research and Strategy for BlackRock Real Assets
Bruce Wan is the Head of APAC Research and Strategy for BlackRock Real Assets.
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