Constructing a Global Real Estate Portfolio - Taking a Multi-Asset Approach - October 2014
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Constructing
a Global Real
Estate Portfolio
Taking a Multi-Asset Approach
October 2014
The document is intended for institutional investors
and investment professionals only and should not be
distributed to or relied upon by retail clients.Introduction
The last commercial real estate cycle illustrated to investors the case for
diversifying globally. However, the heterogeneous nature of real estate,
within markets and between countries, means that investing on a global
basis requires a clear strategy and, we argue, a multi-asset approach.
In this paper, we explain why defining the size, structure, liquidity and
risk of the underlying markets is key to implementing a multi-asset
Anne Breen strategy and constructing global real estate portfolios. We also examine
Head of Real Estate
the implementation risk that is unique to real estate, given the substantial
Research and Strategy
effects of local taxation, business practices and legal conditions on investing
in the asset class. Finally, we consider the challenge for investors in
measuring performance and maintaining a dynamic approach to strategy.
Executive summary
¬ The global financial crisis resulted in significant divergence in performance between real estate
markets, and highlighted the benefits that can be gained from taking a broader approach to real
estate investing.
¬ Diversifying real estate investments, by both market and asset type, can enhance returns, reduce
risk and provide liquidity benefits but requires a dynamic investment strategy.
¬ Key considerations include disparities in market size and characteristics, regulatory constraints,
liquidity and other risks, which can occur at a regional, country and asset-type level.
¬ In order to construct optimal global real estate portfolios, Standard Life Investments has
created a proprietary tool to measure the multifarious risks across geographies and rank
countries accordingly.
¬ Measuring real estate performance is also uniquely challenging and Standard Life Investments
has worked with IPD to create a global hybrid benchmark suitable for a multi-asset real estate
fund and strategy.
2 Constructing a Global Real Estate PortfolioDefining the bricks and mortar
Before delving into the merits or pitfalls of building a global real estate
portfolio, or even a multi-country strategy, it is worth taking some time to
consider firstly, the various routes by which investors can gain exposure
to the asset class, and, secondly, to define the size and depth of the
available universe. We also need to acknowledge that the physical structure,
ownership and geography of real assets contribute significantly to the ability
to deploy an investment strategy. For example, does the quality of building
exist? Who owns the title of the property? If the asset is located on another
continent, can investors try before they buy, far less manage?
In the absence of any significant real estate as partners in a private vehicle, where access
derivatives market globally, we suggest there to either experienced managers or specialist
are four main routes to investing in real estate. markets are a key attraction. The fourth possible
The two most obvious access routes are owning route for investment could be through lending,
a building directly and buying a share of a either directly or again within a vehicle. Each of
listed company, which owns and manages real these methods of investing has advantages and
estate assets. However, investors also have disadvantages, principally around control and
the option to combine their equity and invest liquidity. These are summarised in Chart 1.
Chart 1: Routes to real estate investing – the pros and cons
Unlisted Indirect Listed Property Commercial Real Estate
Direct (private) Securities (public) Debt (CRED)
Pros ¬ Low correlation with ¬ Compromise ¬ Liquidity ¬ Low correlation with
other asset classes between direct ¬ Transparency direct real estate
¬ Ability to create and listed ¬ Wide choice ¬ Low volatility
customised portfolios ¬ Low volatility (other of investment ¬ Strong income
¬ Full control than highly geared opportunities correlation with
¬ Ability to exploit vehicles) ¬ Access to interest rates
market inefficiencies ¬ Can be customised local expertise ¬ Low capital risk (on
¬ Low volatility to meet investors’ ¬ Low implementation senior loans)
needs risk
¬ Access to ¬ Short-term
management mispricing in
expertise the market
Cons ¬ High implementation ¬ Poor liquidity ¬ Less control ¬ Lack of control
risk ¬ Often high fees ¬ Higher ¬ Limited liquidity
¬ Size constraints and management correlation with ¬ Relationship driven
¬ Administrative costs charges equity markets market
¬ Expertise in each ¬ Lack of control ¬ Higher short- ¬ Poor market data and
local market term volatility transparency (Europe
¬ Liquidity poor in ¬ Not very effective in & Asia)
select markets accessing higher ¬ High implementation
opportunistic risk
rate-return ratios
Source: Standard Life Investments, September 2014
Constructing a Global Real Estate Portfolio 3In many ways, the need to illustrate the real estate exposure brings liquidity benefits
variance between the vehicles underpins the but with increased risk. Also, in real estate, size
complexity of investing on a multi-asset basis. really does matter. By exploring the underlying
Having full control of an asset, especially in markets we can begin to shape liquidity on a
smaller or immature markets, can bring liquidity multi-dimensional basis.
problems, while, as we touch on later, listed
Chart 2: The global real estate universe
Direct
Debt
Listed
North America
Private
Europe
Asia Paci c
Source: INREV/ANREF/NACREIF (Q1 2014), EPRA/NAREIT (Q1 2014), DTZ (2013), IPD (2013)
Direct real estate likely to grow in depth. This will be as a result
of more frequent external valuations, more
Typically, direct real estate markets have
reporting requirements from investors, and
been somewhat opaque, not just in terms of
also the increased data collection by IPD in
performance but also in terms of quantifying
less transparent markets – principally Asia but
the size of the universe. Investment Property
also Europe. Secondly, the market size is likely
Databank (IPD) has made great strides in the
to benefit from ‘natural’ growth in emerging
last couple of decades at estimating the size
markets, as occupational demand for quality
of the universe. IPD estimates the market size
stock increases, underpinned by a growing
of each national property investment market
service sector and maturing financial markets.
by determining the most accurate domestic
approximation of the unleveraged value of the
‘professionally managed’ real estate portfolios Listed real estate
in each market. There are limitations to this The listed real estate universe is measured by
approach, however, around the underlying the market capitalisation of real estate stocks
transparency of the markets and the depth of and estimated to be around US$1.3 trillion.
the institutional investor market. Chart 3 illustrates the global listed market, as
measured by EPRA/NAREIT indices.
At the end of 2013, IPD estimated the size of
the real estate universe to be US$6.8 trillion. Of The US is by far the largest and most developed
this total, 37% is estimated as North American, market and represents around 40% of the
38% European and 25% as Asia Pacific real total universe. Importantly, the US listed real
estate. Globally, those markets with the most estate market experienced tremendous growth
developed and the longest track record of data between 1992 and 1997, where it grew from
are the largest: the UK, US, France, Japan, a market capitalisation of less than $9 billion
Australia and Canada. The estimation of the to nearly $128 billion. This growth was due
size of the market will grow for two key reasons. to the proliferation in the number of publicly
Firstly, institutional real estate markets are traded real estate investment trusts (REITs) and
4 Constructing a Global Real Estate PortfolioChart 3: The listed real estate universe
US
Canada
Australia
Japan
Singapore
Hong Kong
New Zealand
Europe ex UK
UK
Source: EPRA/NAREIT Developed Index March 2014
overall equity market capitalisation. It was also directly in secondary locations or into a share
underpinned by a number of important events of one of these large REITs or developers. Direct
and legislative changes to the US REIT structure. investment involves the acquisition of long
These changes made REITs an attractive leasehold interests, as the SAR government
investment to a wider range of investors, owns all land in Hong Kong Island and Kowloon.
including institutions, and laid the foundations While sales of entire buildings do occur,
for what has become known as the ‘modern strata title interests (floors or part floors) are
REIT era’. Today, the US universe is dominated more common.
by equity REITs (91%) that engage in real
estate investment and development (i.e. direct The Japanese listed real estate market is close
ownership of real property). The remainder of in size to the Hong Kong market at circa US$180
the universe comprises mortgage REITs. The billion. This is split approximately 40/60
current US REIT market is deep and diverse, between REITs and developers. Japanese REITs
offering investors the ability to invest in specific have evolved over a slightly longer period than
sectors such as healthcare, malls, multi-family those in Hong Kong, since 2000. The JREIT
or offices. No other global REIT market offers market has grown from about ¥250 billion in
investors such a focused and diverse pool of 2001 to ¥8 trillion in February 2014 – above
real estate sectors and stocks. the pre-Global Financial Crisis (GFC) peak of ¥7
trillion. There were 45 listed REITs in Japan, as at
At approximately US$200 billion, the Hong Kong 30 April 2014, with a total market capitalisation
listed market is the next largest globally. The of US$80 billion. JREITs are highly transparent,
market is characterised by a large share of listed have ample equity capital and comparatively
real estate developers. Development activity strict financial discipline. For example, there is
is strictly prohibited within REIT structures, a loan-to-value (LTV) ratio cap of 55%, which
which, in themselves, only date back to 2005. makes them relatively low risk. The properties
Although Hong Kong is a liquid office market, themselves are generally focused on Tokyo
much of the investment activity is located metropolitan areas and JREITs have de facto
outside the Central area due to the dominance specialisation in the real estate leasing
of domestic investors and developers. business as there is a limit on development.
Companies such as Hong Kong Land, Swire and The remaining US$100 billion in the Japanese
Sun Hung Kai have tended to keep properties listed real estate sector is made up of listed
within their own portfolios and, as such, real estate developers.
investors face the option of either investing
Constructing a Global Real Estate Portfolio 5A notable feature of the listed real estate The private real estate sector
universe is the relatively small size of the
The private real estate sector refers to private
European market, particularly outside the UK.
non-listed real estate vehicles. Globally, this
Excluding the UK, European listed real estate
sector is smaller than the public markets, and
represents just 10% of the overall real estate
is estimated at around US$0.46 trillion. This
EPRA/NAREIT universe, and just 7% of the
total is combined from the size of the indices
estimated direct universe. This compares with
produced by each of the industries in each of the
North America and Asia Pacific where listed real
regions – INREV, ANREV and NCREIF. The poor
estate represents 23% and 32% respectively.
representation of Asia Pacific private vehicles
This lack of depth can be associated with the
within this total is notable. These make up just
relative immaturity of REIT legislation in Europe.
18% of the global figure, compared with 38%
France was the first of the six large European
and 44% for the US and Europe respectively.
markets to introduce a REIT regime in 2003 and,
There are many logical reasons for the relative
consequently, is the largest market across the
size of indirect unlisted real estate across
region. The UK was the next major market to
Asia. European and North American investors
introduce REITs in 2007 and is the next largest by
have shied away from substantial investment
size. The introduction of REITs in Germany was as
in the Asian region for reasons such as lack of
recent as 2007, and 2009 in Spain and Italy. As a
transparency, regulatory risk both in terms of tax
result, these markets are extremely small relative
and title issues, cultural/language hurdles, and
to the listed universe and their domestic direct
underlying liquidity.
real estate markets. Why is this so significant for
a global investor?
Commercial real estate debt
¬ Liquidity – the average REIT capitalisation The global commercial real estate debt
outside the UK across Europe is $4 billion. (CRED) market is extremely diverse. Total debt
This compares to markets such as Hong associated with the real estate sector will be
Kong where the average capitalisation is composed of direct bank lending, insurance-
$14 billion. There are 15 REITs with a backed lending, government-backed debt,
market capitalisation greater than $10 billion unsecured debt issued by REITs, revolving
in North America, 14 in Asia Pacific and just credit facilities, commercial mortgage-backed
three in Europe – only one of which is outside securities (CMBS) issuance and covered
the UK. Assuming a global fund of $2 billion bonds. For the purposes of this paper, we have
looked to gain exposure to even the larger- estimated the potential size of the overall CRED
cap stocks in Europe, given trading volumes, market by applying the average leverage ratio
investment could take up to three weeks across the regions, sourced from various direct
for an allocation of 2% of fund value. real estate data providers, to the estimated
This compares to markets such as the US, direct real estate universe. On this basis, the
where it more typically takes up to five days. North American debt market represents the
¬ Macro investing – on a country basis, largest share of the estimated total, at 43% of
investing across Continental Europe US$3.8 trillion with an LTV of 65%. The European
presents the challenge of stocks not and Asia Pacific debt markets are 38% and 22%
exclusively focused on real estate in their respectively, given their lower average LTVs of
domestic market. For example, Unibail, the 56% and 50%. Of this global total, around 80%
largest Eurozone stock by far, is invested is estimated to be private debt.
across 11 European jurisdictions in major
retail centres. As illustrated, the diversity of the global
real estate universe, the complexities of
¬ Sector cycles – unlike the US, the European ownership, the history and evolution of vehicles
market does not offer the ability to invest on a and the varying underlying levels of liquidity
sector basis, and multi-family, healthcare and and risk, underpin the requirement for a
hotel REITs are virtually non-existent across multifarious approach to building a global real
the region. estate portfolio.
6 Constructing a Global Real Estate PortfolioIs global diversification necessary?
The debate about the benefits – or not – of global diversification has been protracted, but the
GFC settled the score in favour of diversification. During that period, the disparities in real estate
performance in key global markets were significant, as illustrated in Charts 4 and 5.
Chart 4: Real estate performance – 5 years Chart 5: Real estate performance – 11 years
Global Real Estate Multi-Asset Capital Value Indices Global Real Estate Multi-Asset Capital Value Indices
120 300
100 250
80 200
60 150
40 100
20 50
0 0
Dec 07 Dec 08 Dec 09 Dec 10 Dec 11 Dec 12 Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec
01 02 03 04 05 06 07 08 09 10 11 12
* Gilberto Levy - Investment grade price only (not income)
* Gilberto Levy - Investment grade price only (not income)
Denmark France Germany Ireland Netherlands Norway Sweden Denmark France Germany Ireland Netherlands Norway Sweden
UK US (Major markets) Australia Canada Global REITs US CRE Debt* UK US (Major markets) Australia Canada Global REITs US CRE Debt*
Source: IPD, Gilberto Levy as at 31 December 2012 Source: IPD, Gilberto Levy as at 31 December 2012
Of course, one of the key criticisms of real multiple real estate investment vehicles, such
estate data and indices is around smoothing as direct assets, REITs or debt. In the period
and their construction from valuation data between 2001 and 2012, the range in capital
rather than strike prices. In order to achieve values between the major global indices
a truer volatility measure, charts 4 and 5 equates to 200%, or 10.5% per annum. In
use quarterly capital-value transaction- the five-year period following the GFC, values
linked indices from IPD. IPD has developed a in the weakest performing market (Ireland)
hybrid index, which incorporates transaction underperformed the strongest market (Canada)
information with the standard valuation data, by 270%, or by 30% per annum.
in order to give a more robust measure of the
volatility. For the purposes of illustration, REIT It is also interesting to note that over this
markets are grouped together in one series, same period since 2001, the UK, Denmark and
‘Global REITs’. To illustrate the performance of Sweden have shown the same level of volatility
CRED, we used the US data series provided by as Southern European markets. This volatility
Gilberto Levy, which produces mark-to-market represents less than half that of Ireland but
data on investment grade mortgages, albeit more than three times that of Canada and
only for the US – no other data series currently Australia. Not surprisingly, the mark-to-market
exists for Europe or Asia. CRED data series, in terms of volatility, is half
the level of the direct real estate market.
The data clearly supports the case for
diversified exposure across geographies and
Constructing a Global Real Estate Portfolio 7Chart 6: Correlations across real estate markets
US Major Cities
Neththerlands
US CRE Debt
Global REITs
Denmark
Australia
Germany
Sweden
Norway
Canada
Ireland
France
UK
Denmark 1.00
France 0.53 1.00
Germany 0.19 0.25 1.00
Ireland 0.28 0.35 0.32 1.00
Netherlands 0.26 0.56 -0.17 0.20 1.00
Norway 0.38 0.33 0.32 0.21 0.08 1.00
Sweden 0.09 0.15 0.12 0.19 -0.19 0.35 1.00
UK 0.16 0.26 0.27 0.23 0.15 0.14 0.00 1.00
US Major Cities 0.23 0.53 0.16 0.55 0.39 0.19 0.20 0.50 1.00
Australia 0.27 0.61 0.14 0.58 0.52 0.24 0.28 0.38 0.73 1.00
Canada 0.24 0.52 0.13 0.48 0.34 0.20 0.32 0.33 0.71 0.84 1.00
Global REITs 0.02 0.16 -0.32 -0.03 0.12 -0.03 0.05 0.37 0.14 0.14 0.05 1.00
US CRE Debt 0.16 0.11 -0.03 -0.05 0.19 -0.00 -0.19 0.21 0.17 -0.05 -0.08 0.27 1.00
Sources: IPD, EPRA/NAREIT, RCA, Gilberto Levy US Data, Standard Life Investments, 31 December 2013
Simply looking at historical capital values and This supports the argument for diversifying real
volatility is not enough to support a global estate exposure on a global basis and across
diversification strategy. Understanding how the capital stack: direct investment, listed
correlated the markets are will also be relevant. exposure and real estate financing.
Chart 6 illustrates correlation across the global
markets and highlights a few significant points. But what are the risks?
Among the market and asset-specific risks, real
¬ Only three markets (Canada, Australia and estate investing also requires an awareness
US) display a correlation of greater than and measurement of liquidity, currency, tax
70%. structuring and implementation risk. Our
analysis, so far, broadly covers the ‘typical’
¬ CRED shows very low or negative correlation
statistical measures of risk. Currency and tax
with direct real estate markets.
risk are in many ways bespoke to the underlying
¬ Germany shows the lowest relative investor and, therefore, we do not propose
correlation to its neighbours among the to cover these issues in this paper. However,
EMU markets. liquidity and implementation of a global
strategy are relevant to any investor globally
¬ Sweden is generally the least correlated to
and are worthy of further analysis.
any other real estate market.
Liquidity or illiquidity in real estate terms
Therefore, despite the globally synchronised
is a significant topic in itself with several
nature of the GFC, the performance of real
dimensions. Here we should consider liquidity
estate markets and formats has varied widely.
under three broad areas.
8 Constructing a Global Real Estate Portfolio¬ Vehicle or asset type – in practical terms, ¬ Market liquidity – at a country level, real
investing in REITs typically offers same day estate trading volumes vary massively. This
trading. Assuming a willing buyer and seller, is intuitive given the significant variance
transacting direct real estate assets can take in the size of underlying economies and
anywhere between three and six months, physical stock (see Chart 7). Looking at
depending on the complexity of the deal, trading volumes in the five-year period
the readiness of the seller to transact or the before the GFC alongside the five-year period
jurisdiction, which may involve structuring post the crisis does not significantly change
a special purpose vehicle. Investing in a the global ranking. As Chart 8 illustrates,
private real estate fund will typically involve the US is the largest global market in terms
a due diligence period similar to transacting of commercial real estate trading volumes.
in direct assets, as the investor will likely Outside the US, the UK, Germany, France and
undertake due diligence not only on the Japan have the next highest trading volumes.
assets but also on the management team. This would suggest that these large and
In terms of trading, redeeming units within sophisticated real estate markets are most
a private fund can be extremely illiquid, liquid. But liquid for whom? Over the last
depending on the point of the cycle and year, only around US$4 billion of commercial
market demand. A number of funds will offer a real estate was transacted in North America
liquidity ‘promise’ to meet redemptions over by cross-border investors, according to RCA.
a two to three-year horizon. CRED liquidity is This compares to US$112 billion across
somewhat more difficult to quantify. However, Europe for the same 12-month period.
we can assume it is less liquid than direct Similarly, in the Japanese market, on average
real estate. This is because of the level of 90% of trading is domestic. This compares
due diligence required on both the asset and to European markets, where non-domestic
the borrower, the smaller pool of potential investors can account for between 30% and
investors and the duration of the loan. 50% in the UK, France and Germany.
Chart 7: Commercial real estate investment volumes (2007-2014) by asset size
%
100
90
80
70
60
50
40
30
20
10
0
Sweden
Canada
South Korea
US
Singapore
China
Japan
India
Australia
Hong Kong
France
UK
Poland
Germany
Spain
Italy
Netherlands
Czech Republic
Hungary
Belgium
Ireland
Finland
PortugalChart 8: Trading volumes
Commerial Real Estate Trading Volumes (>$10m)
US=$155bn p.a.
70
60
50
40
30
20
10
0
Sweden
US
UK
Germany
France
Netherlands
Spain
Italy
Poland
Finland
Belgium
Czech Republic
Portugal
Hungary
Ireland
Japan
China
Australia
Hong Kong
Singapore
Korea
Canada
Volume 2008-2013 p.a.
Volume 2003-2007 p.a.
Source: Real Capital Analytics, Standard Life Investments, 31 December 2013
¬ Asset size – the nature of domestic The risk of implementing a strategy
ownership, the underlying size of the For direct real estate, implementation
physical stock and the size of the underlying risk is significant. The nature of the asset
economy will shape the average lot size class presents risks around the regulatory
of assets traded in any real estate market. environment, ownership and security of
This is the next liquidity dimension we must ownership, accessing stock, corruption, and
consider. For any large fund, say greater rapid and frequent changes in legislation – a
than US$2 billion, diversifying globally key feature of emerging markets. There are
could present a challenge. Let’s compare also risks related to the implementation of the
two markets such as France and Hong Kong. exit strategy, such as liquidity. A measurement
Firstly, France’s total annual trading volume of these risk components must keep track of
is typically around twice that of Hong Kong’s. changes in business and real estate market
In addition, the local ownership ‘strata’ title cycles. Therefore, risk scores should be dynamic
in Hong Kong tends to mean smaller floors and could change over time.
within buildings trade hands more frequently
than larger assets, which are more typically As outlined in our previous paper ‘Risk in a
held by REITs. As illustrated, this means that Global Real Estate Portfolio’, our approach,
on average a maximum of just eight to ten using our proprietary GREIR tool, concluded in
large assets (greater than US$100 million) the calculation of a risk score for a total of 60
trade in Hong Kong per quarter compared to countries across the globe (see Chart 9).
between 20 and 30 in France.
10 Constructing a Global Real Estate PortfolioThis global risk score can be used as a first The impact of higher risk scores in large markets
filter in portfolio selection, with allocations like France, Italy and Japan has been driving
reflecting the investor or fund risk appetite. The up the global level of real estate risk. Examples
second application requires the translation of of countries that have become more risky over
the risk score into a risk adjustment factor. For the test period are Portugal and France. Risk in
this conversion, we have developed a simple Portugal continues to rise, as its rank has gone
exponential tool – sense checking the results from 22nd in 2009 to 32nd in 2013, falling
against existing disparities in risk around the 10 positions in the global ranking. A weaker
globe and back testing across changes that competitive position, less transparency, a more
have materialised in the last five years. illiquid real estate market and the Eurozone
crisis all contributed to the increase in risk.
Back testing the global GREIR scores on an France’s rank has gone from sixth in 2009 to
unweighted basis indicates that risk generally tenth in 2013. The major driver of the increase
increased from 2009 to 2011 and then reduced. in risk is the Eurozone crisis. However, the
The unweighted score does not reflect higher/ rankings point to a loss of competitiveness
lower risk in large/small markets. The change and innovation in France, as well as a more
in the global score weighted by market size, on restrictive business environment (ease of
the other hand, indicates that real estate risk business ranking).
increased, but the rate of increase is slowing.
Chart 9: Global real estate implementation risk (GREIR) tool - components
GREIR components Q3 2014
10
9
8
7
6
Risk score
5
4
3
2
1
0
UK
US
Germany
Canada
Sweden
Australia
Finland
Switzerland
Netherlands
France
Hong Kong
Singapore
Denmark
Japan
Norway
Belgium
New Zealand
Ireland
Austria
Spain
Poland
Italy
China
Czech Republic
Korea
Israel
Malaysia
Portugal
Brazil
Saudi Arabia
Qatar
Turkey
Russian Fed
Romania
Chile
Mexico
Slovak Republic
Hungary
Thailand
South Africa
India
Greece
Slovenia
Philippines
Colombia
Bahrain
Peru
Argentina
Croatia
Indonesia
Panama
Vietnam
Venezuela
Uruguay
Serbia
Ukraine
Egypt
Guatemala
Pakistan
Kazakhstan
Ease of doing business Competitive Innovative Corrupt Transparent CDS spread Market size
Source: Standard Life Investments, September 2014
Constructing a Global Real Estate Portfolio 11Is there a solution?
So far, we have illustrated the necessity for a Chart 10: The optimal solution
globally diverse real estate portfolio to adopt a
multi-asset strategy. Perhaps a short re-cap at % Global Optimised Portfolio Efficient Frontier ALL CRE Assets
this stage would be useful. 10
¬ Complexities of ownership, history and 9.5
the evolution of real estate asset types
vary globally.
Average Return
9.0
¬ Underlying levels of transparency, liquidity
and risk in real estate markets differ 8.5
substantially.
¬ Investing across global markets and across 8.0
the capital stack (directly, REITs or CRED)
improves diversification. 7.5
2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 %
Standard Deviation
Any investment solution should consider the
Source: IPD, RCA, Thomson Reuters, Standard Life Investments,
‘price’ of these risks and the implementation as at 31 December 2012
of a solution in the context of the existing
investment universe. Also, optimal portfolios
along the efficient frontier is illustrated in
will vary by appetite for risk and the requirement
Chart 11. In running the optimiser, we have set
for liquidity. Crucially, we need to understand
a constraint where the minimum percentage
what is the price of this liquidity? Importantly,
exposure to any individual market or asset type
can the inclusion of CRED reduce the volatility
was 1% with a maximum of 10%. Not setting
injected into a global liquid solution by REITs?
a limit on allocation would mean the portfolio
would be heavily skewed to the lower-risk, less
In modelling the solution, we have considered
volatile markets. We can observe a number of
the same transaction-linked data as in previous
characteristics from the optimisation.
analysis but on a total return basis, i.e. not just
capital values. Also, we have ungrouped global
¬ The allocation to direct real estate varies
REITs into their respective EPRA/NAREIT country
from 82% in the lowest risk portfolio to 47%
level indices. Optimising data on this basis
in the highest.
brings its own caveats – using historic data is
not a guide to the future – but it does allow us ¬ Listed real estate holdings vary between 8%
to look holistically at a portfolio solution across in the lowest risk portfolio to 52% in the
multiple asset types. highest.
¬ CRED allocation varies from 10% to 1% from
The obvious caveat is that the ‘optimal’ solution
the lowest to highest risk portfolio.
illustrated in Chart 10 is run on the basis of
historic returns, volatility and covariance. The ¬ Substantially increasing listed exposure
efficient frontier is nicely curved, suggesting from 29% to 52% along the frontier only
a significant positive contribution from marginally increases the prospective return
diversification. The range of portfolios sitting by 50 basis points.
12 Constructing a Global Real Estate PortfolioChart 11: Optimising risk and reward
Optimising Portfolio Risk and Reward - All CRE Assets
Reducing Portfolio Return, Reducing Portfolio Risk Increasing Portfolio Return, Increasing Portfolio Risk
100
90
80
Listed
70
60
% Allocation
50
40
30
Direct
20
10
0
10% CRED 1% CRED
Hong Kong Listed Canada Listed Singapore Listed Australia Listed Europe Ex UK Listed
Japan Listed UK Listed US Listed GL Debt Canada Direct
Australia Direct US (Major Markets) Direct UK Direct Sweden Direct Norway Direct
Netherlands Direct Ireland Direct Germany Direct France Direct Denmark Direct
Sources: NCREIF, IPD, Thomson Reuters DataStream, Giliberto Levy Index, 31 December 2012
Data constraints - minimum 1% exposure to any region and maximum 10% exposure also.
As we have illustrated, liquidity and ¬ build a global ‘relative value’ indicator
implementation risk vary considerably by across multiple real estate asset types,
market. Therefore, an allocation to small,
¬ within each asset type, indicate across
illiquid markets may not be achievable. Testing
markets where we see greatest value and
this theory, we re-ran the optimisation with
performance opportunities,
the additional constraint of markets only
ranking highly on a GREIR basis. The results ¬ within each market/geography, indicate
are interesting. Ireland and Norway direct relative pricing dependant on the method
real estate no longer feature at all in optimal of accessing exposure.
portfolios and the target allocation to UK direct
typically averages 10%. Assessing such value hinges on the underlying
view of the real estate market and the domestic
The solution requires a dynamic strategy risk-free rate. The forecasts for market
Investing on a multi-asset basis across performance then underpin an assessment
global real estate fundamentally requires: of the pricing in real estate public markets.
an understanding of the valuation of the Overlaying this must be the company’s
underlying real estate assets (which varies underlying exposure (i.e. single country
globally); an ability to analyse, track and score or diversified), its debt to asset level, the
financial metrics in tradable securities; the frequency and practices of domestic valuations
holistic collation and interpretation of market and the free float of the stock. Comparing
data across lending and equity sources; and a pricing and prospective returns from private
solid process of forecasting prospective returns. vehicles and real estate debt can be somewhat
With these skills in hand, we have constructed more complex. Transparency and transaction
additional infrastructure around the existing data is thin for these vehicles and varies
Standard Life Investments real estate House substantially between markets. Where the data
View in order to: is available, we will include it within the model.
Given the pace at which listed markets move,
this model must be dynamic.
Constructing a Global Real Estate Portfolio 13Chart 12: Multi-asset House View
CRE Multi-Asset Web 1 Year 1 Yr View
UK Direct
UK
Heavy
UK Listed
Very
Japan Direct
Europe Private Vehicles
House View European CRED
Singapore Europe
Neutral US Direct
Japan Private Vehicles
Heavy
UK Private vehicles
Direct Europe Direct
UK CRED
US Direct
Europe Listed
Listed US Listed
Neutral
Australia Private Vehicles
Hong Kong underweight US Japan CRED
Singapore Listed
Singapore Direct
Private Singapore CRED
Canada Direct
overweight Canada Private Vehicles
Light
Canada CRED
Hong Kong Direct
Debt Hong Kong Private Vehicles
Hong Kong CRED
Japan Canada
Light
Very
Australia
Source: Standard Life Investments, September 2014
Chart 12 is the graphic illustration of the model. In this example, we were, on a multi-asset
basis, advocating an overweight position to UK direct real estate, Japanese direct real estate,
UK listed real estate, European (ex UK) private vehicles, and European real estate debt. Given
our weaker expectations for other markets, such as Canada and Hong Kong, the illustration
shows that we advocate an underweight position, on a multi-asset view, to both markets. In
other words, in this example, the listed real estate companies on average are not pricing in the
downside we anticipate for direct markets.
Chart 13: Measuring relative performance on market level indices and pooled fund
performance indices. Most recently, Standard
Life Investments has, in conjunction with IPD/
Mark to Market
Direct Real MSCI, scoped and agreed IPD’s first global
Estate hybrid benchmark, which is appropriate for a
Commercial Real
Indices
Estate Debt
(IPD)
multi-asset real estate fund and strategy.
The main requirements of such a benchmark are
Listed Real Estate Quarterly Fund that it be global in nature and timely in delivery.
Indices Indices Compromising on either of these two factors
(EPRA/ (IPD, PREA, would diminish the value of the benchmark to
NAREIT,MSCI) INREV, ANREV) any fund manager. We would suggest valuations
need to be re-appraised at least once a quarter
Source: Standard Life Investments, September 2014 to achieve a measure of mark-to-market pricing.
Every year, the IPD research team estimates
market sizes of the investable global real estate
Measuring relative performance
universe. As a result, the benchmark will remain
We have already highlighted the disparities
independent in terms of its construction and
in sizes, transparency and sophistication of
production. It will also develop as real estate
global real estate markets. It is, therefore,
markets and valuation practices mature.
perhaps not surprising that the measurement of
The direct and listed real estate split is also
performance on a multinational or global basis
established by IPD/MSCI and this split,
is not straightforward. Unlike equity and bond
established every year, will be continually
markets, there is currently no ‘off the shelf’
reweighted. In 2014, this split is 65% direct
market index that we can apply as a benchmark
real estate and 35% listed real estate, based
to global real estate. IPD, the market leader in
on the current IPD estimate of the market
global real estate benchmarking, is at varying
size and the MSCI standard listed global real
stages of success in measuring and reporting
estate return index.
14 Constructing a Global Real Estate PortfolioConclusion
Based on the depth of our research, there is clearly a compelling case for diversification in real
estate investing, both by market and by asset type. We can conclude that diversifying both across
geographies and across the real estate capital stack enhances returns, reduces risks and can provide
investors with a liquidity solution should they seek one.
Investing globally and across multiple asset types is by no means commonplace in real estate and
requires a dynamic approach. In doing so, investors must consider carefully the risk of the domestic
market and the risk of implementing a strategy. The underlying shape, ownership and size of the
market are significant in implementing this strategy.
At Standard Life Investments, our multi-asset investment perspective seeks to deliver a dynamic
view across real estate investment, whether as a direct owner, a shareholder, a fund partner or a
lender. Underpinning this view is accuracy in forecasting underlying direct real estate cycles.
Constructing a Global Real Estate Portfolio 15Important Information All information, opinions and estimates in this document are those of Standard Life Investments, and constitute our best judgement as of the date indicated and may be superseded by subsequent market events or other reasons. This material is for informational purposes only and does not constitute an offer to sell, or solicitation of an offer to purchase any security, nor does it constitute investment advice or an endorsement with respect to any investment vehicle. This material serves to provide general information and is not meant to be legal or tax advice for any particular investor, which can only be provided by qualified tax and legal counsel. This material is confidential and is not to be reproduced in whole or in part without the prior written consent of Standard Life Investments. Any data contained herein which is attributed to a third party (“Third Party Data”) is the property of (a) third party supplier(s) (the “Owner”) and is licensed for use by Standard Life**. Third Party Data may not be copied or distributed. Third Party Data is provided “as is” and is not warranted to be accurate, complete or timely. To the extent permitted by applicable law, none of the Owner, Standard Life** or any other third party (including any third party involved in providing and/or compiling Third Party Data) shall have any liability for Third Party Data or for any use made of Third Party Data. Past performance is no guarantee of future results. Neither the Owner nor any other third party sponsors, endorses or promotes the fund or product to which Third Party Data relates. **Standard Life means the relevant member of the Standard Life group, being Standard Life plc together with its subsidiaries, subsidiary undertakings and associated companies (whether direct or indirect) from time to time. standardlifeinvestments.com Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL. Standard Life Investments Limited is authorised and regulated by the Financial Conduct Authority. Standard Life Investments (Hong Kong) Limited is licensed with and regulated by the Securities and Futures Commission in Hong Kong and is a wholly- owned subsidiary of Standard Life Investments Limited. Standard Life Investments Limited (ABN 36 142 665 227) is incorporated in Scotland (No. SC123321) and is exempt from the requirement to hold an Australian financial services licence under paragraph 911A(2)(l) of the Corporations Act 2001 (Cth) (the ‘Act’) in respect of the provision of financial services as defined in Schedule A of the relief instrument no.10/0264 dated 9 April 2010 issued to Standard Life Investments Limited by the Australian Securities and Investments Commission. These financial services are provided only to wholesale clients as defined in subsection 761G(7) of the Act. Standard Life Investments Limited is authorised and regulated in the United Kingdom by the Financial Conduct Authority under the laws of the United Kingdom, which differ from Australian laws. Standard Life Investments Limited, a company registered in Ireland (904256) 90 St Stephen’s Green Dublin 2 and is authorised and regulated in the UK by the Financial Conduct Authority. Standard Life Investments (USA) Limited, registered as an Investment Adviser with the US Securities and Exchange Commission. Standard Life Investments Inc., with offices in Calgary, Montréal and Toronto, is a wholly owned subsidiary of Standard Life Investments Limited. Calls may be monitored and/or recorded to protect both you and us and help with our training. www.standardlifeinvestments.com © 2014 Standard Life, images reproduced under licence INVBGEN_14_1215_Global_Real_Estate_Insight_Constructing_Global_R_E_Portfolio_White_Paper_TCM 0914
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