In the past 20 years, real estate has become a global asset class in common with equities and bonds.
CBRE Global Investors believes there is a strong case for a UK pension fund to include an allocation to global real estate alongside its UK portfolio for two principal reasons:
1. Diversification benefits
While income returns from property are fairly stable, total returns display higher volatility. Real estate is a cyclical asset class; these cycles differ significantly from country to country because of their specific demand and supply drivers. Therefore having exposure to more countries will create a more stable total return profile than investing solely in one country.
This is reflected in the heat map (Figure 1) that represents the correlations in local currency total returns for the major developed real estate markets. The data suggests that there is potential to diversify a UK domestic portfolio by investing abroad. Looking forward, it is possible that globalisation of markets may lead to real estate markets becoming more closely correlated but the differences between the UK and other economies around the world is likely to result in diversification benefits continuing.
2. Enhanced returns
The correlation between real estate rental growth and economic growth tends to be strong, which means that there is obvious merit in gaining exposure to markets that are expected to grow at faster rates than the UK. The cyclicality of the real estate markets is reflected in the wide variations in returns across markets.
Dispersion between the strongest and weakest performing real estate markets globally peaked in 2008 at 47.3%. The UK recorded a total return of -21.9% in that year. Being exposed solely to the domestic market in that year would have been extremely damaging to investment performance. In short, the use of cyclicality of global property markets will allow a better risk adjusted return to be earned through top-down market selection by tactically tilting allocations towards markets that offer better return potential.
Accessing the global market
CBRE Global Investors estimates that the global institutionally investable real estate market has a value of $28.1 trillion. This is predominantly made up of assets in developed markets (73% of the universe).
The UK has a relatively large real estate investment market yet represents only about 5.5% of the global investable universe. By broadening allocations to include markets outside the UK, investors can substantially increase their opportunity set. The range of opportunity for investors is diverse across the three principal regions of continental Europe, the Americas and Asia Pacific.
The challenge is how to access global real estate and manage the associated risks. Individual properties have high specific risk relative to their market. CBRE Global Investors uses a propriety portfolio risk management system to assemble portfolios to optimise return for a given level of risk. This helps to manage and control exposure to the main sources of property risk.
Based on thorough research of market fundamentals, allocations should be made top-down to markets that are expected to outperform while ensuring a well-diversified mix of market exposures. Property is a local business and skilled managers create significant opportunities to add excess return at the property level. An on-the-ground network and rigorous due diligence process are required to source assets, and proven local operating partners execute investments in a structured way and actively manage the investments and risk on an ongoing basis.
In summary, CBRE Global Investors believes there are benefits to UK pension funds expanding their real estate allocations beyond their domestic market.
Dugal Hunt, portfolio manager, CBRE Global Investment Partners
Column sponsored and supplied by CBRE Global Investment Partners
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