The Case for Global Real Estate
- Global real estate investments offer the potential for growth—increasingly important as the economic activity of several emerging markets increases more rapidly than that of many developed markets.
- Global real estate investments have historically delivered attractive returns and income relative to traditional investments.
- They also perform differently than stocks and bonds during various market cycles, offering diversification benefits.
- There are a number of ways to invest in real estate, including Real Estate Investment Trusts (REITs), Real Estate Operating Companies (REOCs), and mutual funds and ETFs that invest in them.
When investors think of real estate, they often think of their investment in the roof over their head or possibly a vacation property or a rental unit. But increasingly, investors are setting their sights a bit further afield with global real estate investments.
Why? Global real estate can be a valuable addition to an investment portfolio—complementing the traditional mix of stocks, bonds and other investment options. An asset with a low correlation to other investments in your portfolio can both reduce overall portfolio risk and increase returns. Global real estate offers the potential for growth and income, plus diversification for investors who have a tolerance for risk. Here, we’ll take a look at some of these features and discuss common ways to invest, such as through publicly traded Real Estate Investment Trusts (REITs) or Real Estate Operating Companies (REOCs), both of which are known as “real estate securities.” We’ll also discuss investing through mutual funds or exchange-traded funds (ETFs) that invest in real estate securities.
Capitalizing on global growth
In recent years, there’s been a shift in worldwide economic activity, as measured by gross domestic product, or GDP. While the United States boasts the world's largest economy and stock market, the country's share of the world’s GDP has been declining. Investing only in US stocks means excluding nearly three-fourths of the global economy1 and over half of the world's stock market value.2 Indeed, developed markets, like the United States and Europe, are contributing a smaller share of global GDP, compared to their historical average. Developed market economies accounted for 80% of global GDP in 2000, but only 61% by the end of 2013. In contrast, emerging market economies have grown from 20% of global GDP in 2000 to 39% in 2013.3
Forecasts call for GDP growth in emerging markets like Asia and Latin America to outpace gains in developed markets for years to come. If the balance of economic activity continues to migrate away from developed economies in the United States and Europe, real estate in developing markets can provide a way to tap into ascending economies. Real estate often serves as an effective barometer of economic health. Rising real estate prices and rents indicate strong demand and a healthy economy; conversely, falling real estate prices often portend trouble ahead.
There’s the potential to harness this global growth
Though past performance never serves as a guarantee of future results, as the graphic below shows, global real estate has performed favorably over time relative to a domestic benchmark (S&P 500® Index) and an international benchmark (MSCI EAFE Index). A $10,000 investment in the benchmark global real estate fund index (FTSE EPRA/NAREIT Global Index) in February 2005 would have grown to over $19,000 by June 2014—and that period includes the 2008-2009 financial crisis. Investing the same amount in US stocks—as measured by the S&P 500 Index—would have provided a slightly better return of $19,860. However, the same investment in international stocks, as measured by the MSCI EAFE Index, would have come up short at $17,570.4 Keep in mind that the FTSE EPRA/NAREIT Global Index also experienced greater volatility during this period.
Source: Morningstar Direct. Data as of 2/22/2005 to 6/30/2014. FTSE EPRA/NAREIT Global Index was incepted on 2/22/2005. Past performance is no guarantee of future results. The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product. Dividends and interest are assumed to have been reinvested. Indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested in directly.
Global real estate also has historically provided attractive yields relative to equities and many fixed income options. As of June 30, 2014, global REITs had an average yield of 3.53%, whereas the 10-year Treasury was yielding about 2.53%, and global bonds as represented by the Barclays Global Aggregate Bond Index ex U.S., was yielding only 1.45%. Note that when comparing the yield of global REITs to other fixed income and equity-dividend investments, be aware that global REITs tend to experience higher volatility and are more susceptible to rising interest rates.
Master limited partnerships
Source: Bloomberg. Data as of June 30, 2014. Asset classes are represented by the following indexes: Equities: Global Real Estate: FTSE EPRA/NAREIT Global Index; U.S. Stocks: S&P 500 Index; International Stocks: MSCI EAFE Index; Master Limited Partnerships (MLPs): Alerian MLP. Fixed Income: High Yield: Barclays U.S. Corporate High Yield Bond Index; Corporates: Barclays U.S. Corporate Bond Index; Global Bonds: Barclays Global Aggregate Bond Index ex-U.S.; Treasuries: U.S. Generic Gov’t 10 Year Yield, U.S.G 10YR Index.
A complement to stocks and bonds
As you can see in the graphic below, there’s a natural rotation amongst the best and worst performing asset classes. For example, in 2006, 2009 and 2012, global real estate performed better than stocks, bonds, and commodities; in 2007 and 2008, however, it performed the worst. While global real estate has historically provided attractive returns and income, it can experience greater variability in performance compared to traditional investments given its sensitivity to interest rates and potential country-specific risk. By allocating across multiple asset classes including global real estate, investors can gain diversified exposure that should help dampen volatility at the portfolio level.
Source: Morningstar Direct. Asset classes are represented by the following indexes: Broad U.S. Stock Market: S&P 500 Index; U.S. Small Cap Stocks: Russell 2000® Index; International Stocks: MSCI EAFE Index; Global Stocks: MSCI World Index; Investment Grade Bonds: Barclays U.S. Aggregate Bond Index; Commodities: Dow Jones–UBS Commodity Index; Global Real Estate: FTSE EPRA/NAREIT Global Index. Past performance is no guarantee of future results. Dividends and interest are assumed to have been reinvested. Indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested in directly.
Some investors turn to real estate as an investment because of its reputation as a hedge against inflation. When inflation rises, homes and commercial properties tend to climb in value commensurate with prices for food, energy and other goods. Real estate is viewed as a hedge because as inflation sets in, property owners may also have the ability to raise rental incomes. As a result, some now flock to real estate in times of anticipated inflation, viewing the tangible asset as a way to maintain the value of their wealth.
How can you invest?
Investors considering global real estate have four different options:
- Direct overseas property investment. This could entail potential challenges such as hefty down payments, maintenance obligations and restrictive foreign ownership laws, not to mention the cost of traveling to check on the property.
- Real estate investment trust (REITs). These corporations invest in real estate properties, mortgages or both. REITs are stocks that can be bought or sold on the major exchanges and have to distribute 90% of their income to shareholders as dividends. REITs have special tax considerations and typically offer investors high yields in addition to a liquid opportunity to invest in real estate. REITs also offer a variety of investing styles: Some invest in property in specific geographic regions, while others are widely diversified. Some REITs specialize in property types, such as office buildings, shopping malls, apartments, warehouses, hotels or a combination of properties. Note that too much concentration in any one property type can increase risk.
- Real estate operating company (REOCs). These corporations are similar to REITs in that they own real estate and trade like a stock. However, REOCs don’t have to distribute their cash flow to investors, leaving them free to invest in their holdings in other properties or improvements.
- Mutual funds or ETFs that invest in REITs or REOCs. As mutual funds and ETFs can invest in a number of securities, they can provide diversified exposure across a variety of sectors and regions.
Market-cap vs. fundamentally weighted funds
Most index funds are market-cap weighted, meaning that the largest company by market capitalization, or stock market value, is given the largest weight. Another way to tap into global real estate opportunities is through fundamental strategies, which employ a rules-based discipline in weighing securities based on factors such as sales, cash flow, dividends and buybacks.
This difference in weighting can have an impact on securities included in the fund. To see this impact, we compared the country allocations of a fundamentally weighted global real estate index, the Russell Fundamental Global Select Real Estate index, with a market-cap based index, the FTSE EPRA/NAREIT Global Index.
As you can see below, both indexes have a significant allocation to the US and Japan but there are subtle differences in allocations to some countries. For example, take Hong Kong: The market-cap index has a 7.48% allocation, while the fundamentally weighted index has almost a 10% allocation. For Australia, the market-cap index has a 5.97% allocation, while the fundamentally weighted index has a 9.31% allocation. As an investor, it’s important to be aware of these differences so your portfolio has the exposure that you are expecting.
Source: Morningstar Direct, Russell Indexes, and FTSE Indexes. Morningstar equity industry allocations. Data as of June 30, 2014.
Global real estate can be an attractive addition to an investment portfolio—complementing the traditional mix of stocks and bonds. It offers the potential for growth and income, plus diversification, but before investing in global real estate, it is important to understand the structure of the securities and the potential risks.
I hope this enhanced your understanding of global real estate. I welcome your feedback—clicking on the thumbs up or thumbs down icons at the bottom of the page will allow you to contribute your thoughts. (If you are logged into Schwab.com, you can include comments in the Editor’s Feedback box.)
1. International Monetary Fund’s World Economic Outlook Database, April 2014.
2. S&P Global Broad Market Index, May 2012.
3. International Monetary Fund’s World Economic Outlook Database, April 2014.
4. Morningstar Direct. Data from February 22, 2005 to May 31, 2014. Inception of FTSE EPRA/NAREIT Global Index (TR) was February 22, 2005.
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Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.
Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, shares of ETFs are not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be higher or lower than the net asset value.
Past performance is no guarantee of future results.
Risks of the REITs are similar to those associated with direct ownership of real estate, such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate this risk.
Diversification strategies do not ensure a profit and do not protect against losses in declining markets.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.
High-yield bonds and lower rated securities are subject to greater credit risk, default risk, and liquidity risk.
Master limited partnerships are considered pass-through entities for tax purposes and therefore have special tax considerations.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.
S&P 500® Index is a market-capitalization weighted index that consists of 500 widely traded stocks chosen for market size, liquidity, and industry group representation.
The FTSE EPRA/NAREIT Global Index is designed to track the performance of listed real estate companies and REITS in both developed and emerging markets. By making the index constituents free-float adjusted, liquidity, size and revenue screened, the index is suitable for use as a basis for investment products, such as derivatives and Exchange Traded Funds (ETFs). The FTSE EPRA/NAREIT Global Index incorporates Real Estate Investment Trusts (REITs) and Real Estate Holding and Development companies.
The Russell Fundamental Global Select Real Estate Index ranks and weights global real estate securities by three fundamental measures of company size — adjusted sales, retained operating cash flow and dividends plus buybacks. Fundamental scores are created using the members of the Russell Fundamental Global Index classified as Real Estate or Real Estate Investment Trusts according to the Russell Global Sectors classification scheme. Mortgage and Timber REITs are excluded. Securities are ranked by each fundamental factor, and individual factor weights are averaged to determine overall fundamental weights. Once the index has been created it is rebalanced quarterly using a tranche methodology.
Alerian MLP Index is a composite of the 50 most prominent energy Master Limited Partnerships (MLPs) that provides investors with an unbiased, comprehensive benchmark for this emerging asset class.
Barclays U.S. Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis.
Barclays U.S. Corporate High-Yield Bond Index covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/ BB+ or below.
Barclays Global Aggregate Bond Index ex-US provides a broad-based measure of the global investment-grade fixed-rate debt markets. The two major components of this index are the Pan-European Aggregate, and the Asian-Pacific Aggregate Indices.
The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
US Generic Gov’t 10 Year Yield Index: This index represents the most recently-auctioned 10-year US Treasury Note. The index is updated after each 10-year Treasury Note auction.