In challenging markets, investors seek to minimize risk. Through the benefits of diversification, global REITs may add value to a portfolio.
Previous research has established the significant risk-reduction benefits of U.S. real estate income trusts (REITs) within a mixed asset portfolio consisting of global equity stocks and global government bonds. Given that the U.S. REIT structure has the longest history of all of the structures currently in place around the globe (more than 45 years), and that most REIT markets have only developed within the past 10 years, most studies have been conducted with only the U.S. portion of the market in focus.
However, little research has been conducted to determine if the benefits from owning REITs extend to markets beyond the U.S. Expanding the traditional research to include global REITs is especially important for Canadian and other non-U.S. investors who will need to evaluate the benefits of investing in this asset class. Global REITs and real estate securities may have a significant impact on a mixed asset portfolio consisting of global stocks and global bonds. The questions to address are, Should an investor with exposure to global equities and global bonds seek to diversify by adding real estate? If so, should investors look to global real estate securities as their solution?
Real Estate Research
Research suggests that from a risk-return perspective, investors would gain considerable diversification benefits from adding global real estate securities to their traditional equity and bond portfolios.
Looking at total returns for the major asset classes from 1990 to 2007 (Figure 1), the first step is to consider the annualized return and annualized risk profile for each asset class. The best-performing asset class over the 18-year period was global real estate securities, which generated average annual returns of 10.71% (U.S. dollars). Global bonds had the lowest annual risk at 6.18%. On a risk-adjusted return basis (annualized returns divided by annualized risk), global real estate securities came in higher than global equities but lower than global bonds.
In addition to examining returns, LaSalle Investment Management also analyzed the relationship between each of the asset classes. The relationship between global real estate securities and the other asset classes, as measured by correlation of returns, was low to moderate. This suggests that global real estate securities offered significant diversification benefits because they behaved quite differently from the other asset classes over the time period.
Using global REITs and real estate securities, we are also able to examine the regional relationships of real estate. Looking at correlations within various real estate securities markets, we see that low to moderate correlations existed across all countries and regions, meaning that real estate behaves differently from one region and country to the next (see Figure 2). For example, Canada’s real estate market had a correlation of 0.18 to Australia’s market. Even the relationship between Canada and the U.S. was only moderate, at 0.41, despite the geographic proximity of these two markets and the fact that they serve as each other’s largest trading partners. Low regional correlations between real estate markets suggest that there is a second level of diversification benefits derived from building a global real estate securities portfolio. Therefore, a Canadian investor with exposure to domestic REITs would likely add significant diversification benefits by building a global real estate securities portfolio.
