November 2019 | Finance
Until recently, real estate was typically less than 2 percent of an investment portfolio, and the owners of the majority of commercial real estate in the U.S. were local or regional “mom-and-pop” operations. Both scenarios have changed significantly. Commercial real estate is now about 10 percent of institutional investment portfolios, and there has been a massive shift of ownership to institutional investors such as REITs and private investment funds.
But as interest in the sector grows, and more money flows in, the number of available buildings in the U.S. can’t meet investor demands. Maisy Wong, PhD, Wharton associate professor of Real Estate, says institutional investors and financial advisors should now be paying more attention to the global real estate market.
She recently told participants in the Assessing Commercial Real Estate Investments and Markets program that as competition for deals in the U.S. market gets stronger, and as the need for diversification increases, global markets are becoming more appealing. “Capital markets have become globally integrated in other asset classes. We are seeing the globalization of real estate capital markets now, and the number of cross-border deals will continue to grow,” Wong says. “Many investors are realizing that they have to search globally to find more opportunities.”
But moving into global markets has unique risks that investors need to understand and manage. Wong cites currency as one of them. “If you invest in an office building with U.S. dollars in London, how will your bottom line be affected by Brexit if the pound depreciates? Using Brexit as a case study, we go through different real-life scenarios of how currency risk affects returns and how forward contracts and options can be used to manage currency risk.”
But Wong says there are broader implications for that scenario that must be considered as well: Brexit’s risks go well beyond currency. If banks relocate employees to Europe, for example, how will commercial real estate in London be affected? These types of risks are present in other attractive markets as well. Institutional investors bought $2.7 billion worth of commercial real estate in China during the first quarter of 2019, according to Real Capital Analytics — but do they know the risks and how to manage them?
During the Assessing Commercial Real Estate Investments and Markets program, faculty and participants discuss U.S.-China relations. “The Chinese government plays an important role in its economy,” says Wong, “and many business decisions have to be viewed through that lens. If you’re going to invest in China, you need a framework for understanding the different scenarios that may play out in China, how the government might respond, and how it will affect the U.S. and the global economy.”
Many of the institutional investors and financial advisors to high-net-worth families who attend the program are looking to diversify into cross-border investments. To invest directly, though, they need a partner to work with. “If they’re seeking an investment in Brazil, for example, there is political risk associated with the new administration. A global partner is in a position to assess that risk and identify potential investments,” says Wong.
Participants will discuss how to choose between a number of types of partners, each with tradeoffs. One is a large global firm that has a strong presence in the country you wish to invest in. They have plenty of experience working with foreign investors and are very skilled. Then there are large, publically traded developers in that country.
Another partner type is the dark horse: a small fund with few investors. They have a track record and know how to get things done, but they don’t have the reputation that the first two do. Because they need your capital, they may be more willing to bargain, and the returns could be potentially higher.
But how do you find them? Wong suggests giving the large investor a small amount of money. Over time, as you start looking at the projects they are investing in, you will develop more local connections. And don’t discount your network. You may already have a connection with a small fund that’s investing in the target country.
Ultimately, all three types of investors have relative strengths and weaknesses. Participants will develop a checklist to identify the key partner risks and create an action plan to mitigate those risks.
While getting into these markets, and navigating their formidable risks, isn’t easy, Wong says the potential payoff is worth it. “Real estate is still a local business but investors are beginning to search for opportunities globally. We walk through real cases to develop a mindset to think globally and act locally.”
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