International Diversification Strategies In
A Modern Portfolio Context
by
Paul Thomas Hession
B.S. Business Administration, Boston College
(1976)
Submitted To The Department of Urban Studies
& Planning
In Partial Fulfillment Of The Requirements Of The Degree
Master Of Science In Real Estate Development At The
Massachusetts Institute Of Technology
September, 1990
(c)
Paul Thomas Hession
The Author hereby grants to M.I.T. permission to
reproduce and to distribute publicly copies of this thesis
in whole or in part.
Signature of the aut or
/Paul Thomas Hession
Department of Urban Studies and Planning
Certified by
Marc A. Louargand
Lecturer
Department of Urban Studies and Planning
Accepted by
Gloria Schuck
Chairperson
Interdepartmental Degree Program in Real Estate Development
Rofth
MAS ACHUSETTS1NSTim E
OF TECHNo;
Y
SEP 19 1990
IBRARIES
International Diversification Strategies In
A Modern Portfolio Context
by
Paul Thomas Hession
Submitted to the Department Of Urban Studies & Planning
on September 1, 1990 in partial fulfillment of the
requirements for a the Degree of Master of Science in
Real Estate Development
ABSTRACT
A study of an international diversification
strategy in
real estate was conducted.
The strategy was reviewed in
the context of an institutional portfolio being managed
using Modern Portfolio Theory.
The study analyzes the
correlation of
the United States economy
and the
economies of the United Kingdom, France, West Germany,
Italy and Spain.
The effects of the market-economic
integration of the Member
Nations of the European
Economic Community and the events taking place in Eastern
Europe are addressed. The obstacles and risks associated
with
implementing
an international
diversification
strategy were considered.
The results from the study indicate an international
diversification strategy is appropriate in a Modern
Portfolio Context. The events now taking place in Europe
will have a significant positive impact on the economic
growth of the countries of Western Europe.
It appears
that the countries in Western Europe may share a closer
relationship in the future but there is still benefit in
diversifying within Europe.
The obstacles and risks
associated with investing in international real estate
markets
do not
appear
to
be insurmountable
or
prohibitive.
Thesis Supervisor: Marc A. Louargand
Title: Lecturer in the Department of
Planning
Urban Studies and
ACKNOWLEDGEMENT
I would like to thank Marc A. Louargand for his time,
effort and guidance in researching this subject and
compiling this thesis.
I would also like to thank
those industry professionals I interviewed for the
time they spent with me and the information they
shared with me.
And last but not least I would like
to thank Janet and Ellie for their support and love.
TABLE OF CONTENTS
PAGE
INTRODUCTION
5
SECTION I
THE CURRENT STATE OF THE U.S.
ESTATE MARKET
REAL
7
MODERN PORTFOLIO THEORY
13
DIVERSIFICATION THROUGH INTERNATIONAL
SECURITIES
17
MODERN PORTFOLIO THEORY AND REAL ESTATE
18
INTERNATIONAL DIVERSIFICATION STRATEGIES
AND REAL ESTATE
28
SECTION II
INVESTING IN FOREIGN REAL ESTATE
33
SECTION III
THE CHANGING LANDSCAPE IN EUROPE
39
OVERVIEW OF ECONOMIC PERFORMANCE IN WESTERN
EUROPE
45
REAL ESTATE. MARKETS IN WESTERN EUROPE
48
CONCLUSION
54
END NOTES
57
BIBLIOGRAPHY
58
INTRODUCTION
are
investors
Many
opportunities
Western
now
the real
available in
Europe.
The
interest
markets is being heightened
are taking
place in
In
of the United
returns
real
in
these
real
of
estate
by the dramatic changes that
and social
States are slumping
estate
managers
are
investments
now
diversification
strategies as
volatility
their
in
estate markets
addition, real estate markets in
most regions
Portfolio
investment
the economic, political
climates of Europe.
on
the
considering
looking
at
a means
falling.
international
of reducing
estate
real
are
and the
the
while
portfolios
maintaining their overall returns.
The
first section
of this
thesis considers
international diversification
strategy in a
whether an
real estate
portfolio is consistent with Modern Portfolio Theory.
recent
years,
portfolio
equity-financial
foreign
heavily
in
benefits
of these
overseas
markets will
estate
investments
investments as
diversification" in
have
managers
be
and
reviewed.
a vehicle
a portfolio
invested
role of
to achieve
of
real
"efficient
of investments
evaluated from a historical prospective.
more
The
markets.
the performance
The
In
will be
The application
of
Modern
addressed
Portfolio
Theory
and
benefits
diversification
considered.
the
in
a
The
diversification
appropriateness
real
of
real
estate
merits
of
strategy
as
to
an
in
estate
be
economic-geographic
portfolio
an
real
"efficient"
will
will
be
international
estate
means
and
of
its
limiting
volatility and risk will be explored.
The second section of this thesis addresses the obstacles
and risks relating to investments in foreign real estate.
An international diversification
a domestic
strategy has
many
risks; currency translation,
differences, the
strategy as compared to
additional obstacles
and
language barriers, cultural
availability of market
unusual business practices.
information and
Strategies for dealing with
these obstacles and risks will be discussed.
The final
section explores the relationship
economies of
Italy,
the United
Spain
changes
and
taking
integration of
of
economies
the United
place
in
Eastern
Economic Community
of these changes
of
States.
West Germany,
The
Europe
the markets and economies
the European
The impact
Kingdom, France,
these
tremendous
and
will be
be
the
of the Members
addressed.
on the relationship
countries will
merits of a diversification
between the
explored.
of the
The
strategy that invests in all
or some of these markets will be evaluated.
***SECTION I***
THE CURRENT STATE OF REAL ESTATE MARKETS IN THE U.S.
As we enter the 1990s,
in
States are
In addition, concerns regarding
haunting the industry.
our
and
country's trade
1980s are
excesses of the
slumping and the
United
the
across
estate markets
Real
turmoil.
the U.S. real estate industry is
budget
casting
deficits are
doubt on the economic future of the United States.
The decade of the 1980s was
deregulation of
billions
These
of
and the
U.S.
The 1981
Tax Act
the savings
and loan
industry brought
in the
estate markets
a unique time for most real
dollars
new sources
into the
of capital
real
estate
industry.
industry to
enabled the
grow rapidly for most of the decade.
The
1981
invested
Tax Act
in
real
incentives
estate.
Syndication
quickly to create investment
tax
shelters
for those
provided
for
investments were made
their
firms
who
worked
vehicles for those seeking
income.
Most
of
these
through limited partnerships that
took full advantage of the tax incentives.
In addition,
took large front-end fees
for creating
the syndicators
the investment vehicle.
Most
of these investments were
driven by the tax advantages gained by the investors and
syndication
fees,
not
the
underlying
real
estate
was deregulated
in the
economics involved.
The
savings and
early part
loan industry
of the
decade.
began loaning money to
real
estate
Many of
these institutions
developers involved in high risk
development
projects.
Few
of
the
institutions were prepared to deal with the complexities
of
the
real
estate
development
business.
Loan
executives were given incentives bonuses to produce more
high
yielding
realize
loans
that a
higher
These events took
booming.
for
the bank.
yield also
Many
meant higher
place in a time when
Reaganomics was
in full
failed
to
risk.
our economy was
glory and
few were
looking at downside risk.
The impact of all this was that the real estate industry
was
flooded
with
rushed to satisfy
development
money.
Development
this new demand.
companies
begun overnight.
In 1974,
new
were
It
companies
seemed that new
formed and
projects
were
Money never seemed to be a problem.
the Employment Retirement Income
(ERISA) was enacted.
ERISA
Security Act
instructed pension funds to
minimize the overall risk in their investment portfolio.
Diversification
was mandated.
The Federal
government
was concerned
its assets
fund with all
that a
the risk of a huge
investment vehicle exposed itself to
Most funds had less than 1%
involvement in real estate.
appropriate way to balance risk in
was now viewed as an
an investment
As
portfolio and by the
early 1980s pension
become a significant player
funds had
baby boomers
pension funds on
to
available
Real estate
in real estate.
assets invested
of their
their
had limited
funds
Traditionally pension
loss.
in one
aged
in the industry.
were contributed
and monies
more money was
their behalf, more and
These
invest.
to
funds -had
billions
of
dollars and as the industry prospered and profits soared
so did the appetites of these funds for real estate.
The 1980s represented a "bull market" for real estate in
most
regions of
the
reached an
properties
States.
United
all
reflected the anticipation
time high
Competition
for
pricing
and the
of substantial appreciation.
In addition, foreign money was rapidly being invested in
U.S.
most major
vacancy
markets.
begun
rates had
professionals
buildings
started
under
to
By the
to increase
see
construction
the decade,
end of
and real
signs
with
that
the market
estate
was
the
grossly
overbuilt in all sectors.
A number of
events occurred in
decade that
had a
The first
the second half
substantial impact on
occurred in
1986 when a
of the
the industry.
new Tax
Act became
law.
The Act removed
almost all the incentives related
real estate investment.
The
estate
and
were
extended
eliminated.
vanished
The
most
syndication
as quickly
The second event
depreciable lives for real
as they
firms
credits
described
had come
over 500 points in
and
in general
Financial firms that
above
when the New
The Dow Jones Industrial
Average dropped
one day.
were becoming
concerned about the mounting
were
into existence.
occurred in October 1987
York Stock Exchange collapsed.
the public
tax
Investors
increasingly
trade and budget deficits.
had grown so rapidly
in the 1980s
started to contract and thousands were laid-off.
The
savings and
effects of
loan industry
a slower
developers who
real estate
had borrowed
defaulting on their loans.
found themselves
to feel
market.
millions of
Many
the
of the
dollars began
The institutions immediately
in difficult
"savings and loan crisis"
were complicated
now began
financial times
was underway.
by problems
and the
These problems
in the junk
bond market.
Many of these institutions also invested heavily in junk
bonds.
The
cost of
savings and
loan bail-out
is now
estimated at $500 billion.
The real
estate industry which
had so much
the 1980s was now without liquidity.
U.S. that
full of
had seemed
peril.
The
so safe to
capital in
The markets in the
invest in
projections done on
now seemed
projects that
seemed
all
on
Yields
optimistic.
overly
at as
now looked
were
so conservative
properties
under
were
pressure and rents were constantly being renegotiated.
The
real estate.
opportunities in
of their
that one
Many investors
invest money in U.S.
willing to
managers, who
pension fund
international diversification
its investments
that spread
nations-economies would have less
way to
as a
It would seem that a
minimize risk in their portfolios.
portfolio
finding quality
portfolio yields sink, were now
were seeing real estate
considering
who were
real estate complained
major obstacles was
In addition,
investments.
international
in
interest
investors'
increased
U.S.
in the
capital markets
in the world
the changes
coupled with
market
real estate
the
downturn of
among different
risk than a portfolio
of properties all in one country.
The
Europe.
foreign
markets
Community
European Economic
The
also
has
are taking place
the rapid changes that
increased with
in
certain
in
interest
is
now
working towards the integration of the markets-economies
of its
Member Nations in
Member
Nations
include
1992.
removing
The objectives
the
trade
of the
barriers
between European countries and promoting economic growth
and job
creation.
The
countries now
participating in
the EEC include all the major economic powers in Western
Europe;
the
United
Kingdom, Germany,
France,
Italy,
Spain, Greece, Belgium, Ireland, Luxenburg, Portugal and
the
Netherlands.
Goals
of
the
establishment of
a central bank for
standard
policy and
taxing
Member Nations.
one
Some predict
EEC
include
the
monetary policy, a
currency
that the
for use
by
integration of
Europe will increase the economies of its Member Nations
by as
much as
create a
Japan.
people
6%.
If
the EEC
market of consumers
The
total
is successful
larger than the
market will
as compared
to
approach
the U.S.
and
it will
U.S. and
320
million
Japan which
are
approximately 245 million and 121 million, respectively.
The creation of a European
task.
deal
A European
with the
commission has
many political,
emotional objections.
issues
will also
obstacles it
economy will be a monumental
been established
economic, cultural
to
and
The administrative implementation
be considerable.
appears that
the 12
In spite
of these
governments involved
are committed to the success of this endeavor.
The Berlin
Europe
Wall has fallen
are
now
represents a
being
Europe
opened
to
the
tremendous market with a
up demand for goods and
of
and the markets
is
services.
changing.
The
of Eastern
west.
This
significant pent
The landscape in all
demand
for
housing,
computers, consumer goods and communication equipment is
enormous.
The
changing economic, social
climate in Europe presents
challenge to U.S.
and political
a tremendous opportunity and
investors.
It appears that the U.S.
markets are in need of some
economy and the real estate
to take off
European markets are ready
healing and the
as their economies change and grow.
MODERN PORTFOLIO THEORY
A portfolio investment strategy at
risk.
Placing
a
in
your funds
different
number of
your money in
than putting all of
investments is safer
limit
can
diversification one
through
that
suggests
its most basic level
one company's stock, bond or in one real estate project.
The
this
manner the
reduced.
adopt
likelihood of
portfolio
this
investments.
loss is
a catastrophic
pension funds
instructed
1974
ERISA in
funds in
spreading your
that by
approach assumes
approach
and
to
their
diversify
Markowitz refers to this strategy as naive
diversification and he believed that the conclusion that
this approach limits risks in not supportable.
Markowitz
difference between
diversification.
risks
their
a
significant
and efficient
Efficient diversification balances the
returns in
theory requires
investments
is
naive diversification
and investment
portfolio
there
that
believed
using
that a
a
Modern
a portfolio.
fund manager
scientific
approach
select
that
produces an efficient combination that maximizes overall
investment returns for a given level of risk.
Markowitz
felt the selection
of an investment had to
be based on
the understanding of how that investment interrelated to
the other investments in
of one
a portfolio.
assets performance to
the portfolio
The relationship
that of another
needed to be quantified.
asset in
As one asset's
yield increased the other asset's yield decreased.
relationship was termed a
Modern
Portfolio
covariance.
Theory
efficient balance.
was
to
The proper
This
The objective of
achieve
the
most
mix of investments would
allow the portfolio to earn a steady and reliable return
over
time.
The
volatility of
the portfolio
would be
minimized and significant fluctuations could be avoided.
In 1964,
William Sharpe expanded Markowitz's
including
the concept
believed that
two prices:
of
the rate of
the price
market equilibrium.
return on an
of time and
The price
of time represented the
is earned
by all investors.
premium earned
investment.
Sharpe believed
such
investment
leverage,
limited raw
The selection
should
as
enable
of making the
by applying
Business
Modern
risk can
be
associated with a particular
issues,
management
materials, labor
manager
is the
risks (unsystematic) in a
of investments with
a
of risk.
non-risk return that
that
eliminated.
defined as the uncertainty
asset included
the price
for assuming the unknowns
could be
Sharpe
The price of risk
Portfolio Theory the business
portfolio
theory by
to
financial
shortages etc.
negative covariances
limit
these
risks
and
Sharpe felt
maintain a steady yield on their portfolio.
that an investment rate of return included a premium for
related risks.
taking market (systematic)
can be
defined as
market
at large
Market risks
with the
the uncertainty associated
that
the impact
and
changes in
the
market may have on an individual investment.
Sharpe
developed a
by
risk
related
with
investment
portfolio.
The approach
index representing
termed
A
measures the
that of
the price
measure produced from this
of a security
for time, referred to as
premium.
The
beta coefficient.
The risk
Sharpe
portfolio.
market
analysis was
beta
return to
sensitivity of the investment's
a market
in
the other is
perfectly diversified
a
investment's
the
two investments
examines
an
market
diversified
an individual investment and
which one is
investment.
a
of
covariance
the
measuring
individual
an
determining market
methodology for
demonstrated that
the price
is a combination of
the riskless rate and the risk
premium is
the market
portfolio's
risk premium multiplied by the securities beta.
Markowitz and Sharpe demonstrated in their research that
with the
proper scientific
analysis of market
data an
optimal or most efficient portfolio could be determined.
An investment manager could select
a mix of assets that
eliminates unsystematic risk through diversification and
also provides the investor with the highest return for a
15
given level of risk.
to
a set
of
provide the
To
efficiently
diversified portfolios
optimum return for
determine the
investor
The term efficient frontier refers
best
you must
a given level
possible portfolio
superimpose
that
of risk.
mix for
the investor's
an
utility
function on the efficient frontier.
In
Real Estate
the authors
Investment Strategy
describe four basic steps
efficient two asset portfolio (1).
rates of
Analysis Decisions
Step 1. estimate the
returns and the probability
each investment.
variances
of occurrence for
Step 2. compute expected
for each
covariance of
in developing an
investment.
each investment
Step
returns and
3. compute
and step 4.
the
compute the
optimal combination of the two investments.
Modern
Portfolio Theory
securities
assist
markets.
investment
investing funds
was developed
The
for use
concepts were
managers
in
making
and quantifying risk.
in the
developed
to
decisions
on
The application
of these concepts have been expanded to include the bond
markets
and
foreign
research has been done
Portfolio Theory and
relate
clearly
to
the
their
great
deal
of
diversification strategies as they
the
a manager
portfolio while
A
regarding the validity of Modern
securities
supports
diversification
securities.
industry.
premise
can
This
that
research
through
minimize volatility
maintaining attractive
in
returns.
requires that
Portfolio Theory
Modern
a portfolio
be
reviewed continually adjusting for changes in the market
and business
risks.
ability to react quickly to
investment manager with the
changes
in
if
and
the market
provide an
financial markets
The
necessary to
redeploy
invested funds.
Diversification Through International Securities
Over the past decade advances
made in the technology of
communications have allowed investors to trade with ease
in
foreign
closely the
markets.
Investment managers
markets.
trading in most foreign
never more evident than in
now
follow
This was
October of 1987 when traders
on Wall Street watched with great concern the trading in
Tokyo, Hong Kong and London.
Investment
foreign markets
out
performed
historical data
Information
been attracted
have also
fund managers
because many of these
the
market.
U.S.
was prepared by Morgan
and reported
recently
in
to
investments have
The
following
Stanley Capital
the Wall
Journal:
Country
Investment Returns
5 years
12 Months
Australia
Austria
Belgium
Canada
Denmark
Finland
France
9.2%
114.6%
19.0%
4.2%
49.6%
-21.6%
44.1%
173.0%
430.6%
471.1%
80.6%
283.9%
N.A.
344.8%
Sreet
Germany
Hong Kong
Italy
Japan
Netherlands
New Zealand
Norway
Singapore-Malaysia
Spain
Sweden
Switzerland
United Kingdom
U.S.
According
61.7%
18.3%
39.7%
-13.7%
29.4%
5.7%
40.1%
21.8%
9.8%
27.3%
49.4%
21.0%
16.9%
to Rowe
256.0%
167.9%
331.6%
309.8%
234.3%
N.A.
286.2%
129.4%
411.1%
456.5%
236.1%
186.6%
120.9%
Price-Fleming International
Inc., a
joint venture of Rowe Price Associates Inc. in Baltimore
and Robert Fleming Group in London, investors who placed
30% of their funds in
U.S. stocks
foreign stocks and the balance in
earned higher
return and
experienced less
volatility than
investors with all their
stocks.
funds are available for
Mutual
investors who
securities.
are interested
funds in U.S.
the individual
in investing
Fidelity Investment's
in overseas
Overseas Fund earned
304% over a five year period ended March 31, 1990.
The
information
attractiveness
reported
of
securities market's
demonstrates
overseas
The
U.S.
performance ranks 12th in
5 years 10 countries exceeded
the U.S
the
securities.
12 months and 18th over the last 5 years.
to
clearly
return of
the last
Over the past
a 200% return as compared
120.9% The
Wall Street
Journal
recently reported that in 1979 52% of the total value of
world
equities were
in
U.S.
stocks,
share of total world equities is 34%.
18
today the
U.S.
Modern Portfolio Theory and Real Estate
investment
by portfolio managers
has been used
Real estate
vehicle to
diversify
their portfolios
their returns.
limit the volatility of
as an
and
Real estate has
been traditionally considered a hedge against inflation,
stock
inflation fears,
by research
threat of inflation
as the
stock market falls.
impacted
negatively
typically
is
market
estate.
of real
do the prices
rise so
as prices
The
by
grows the
These relationships were supported
(November 1987) (2).
done by Goldman Sachs
The table below summarizes the relationship (covariance)
between various investments and inflation.
Property REITS Stocks Bonds Inflation
-.14
1
Property
-.28
-.38
.38
REITS
-.14
1
.78
.36
.03
Stocks
-.26
.78
1
.49
-.15
Bonds
-.38
.36
.49
1
-.35
.38
.03
-. 15
Inflation
The results
estate
of the Goldman
prices tend
inflation and stock
on
correlated.
estate
real
This
would be
Sachs study show
to move
in the
that real
same direction
and bond prices tend
as inflation increases.
returns
1
-.35
as
to move lower
The research demonstrates that
estate and
indicates
an excellent
equities
that
are
investing
negatively
in
real
diversification strategy
for
a
portfolio
numerous
articles
relationship
research
hedge
manager.
have
been
between real
confirms that
against
In
1987,
regarding
the
an
The
appropriate
article
was
and Inflation"
than 300 properties concluded
portfolio of
a complete
and
is an
"Real Estate Returns
a diversified
research
and inflation.
real estate
which after studying more
provided
written
estate
inflation.
published entitled
that
Considerable
commercial properties
hedge against
inflation over
the
period 1973-1983 (3).
Since
1974,
portfolio
managers
have
increased
the
portion of their portfolios invested in real estate from
about
1% to
4%
of their
total
assets.
Real
estate
clearly is an appropriate diversification strategy for a
portfolio being
Real
estate
managed using Modern
had
become
an
Portfolio Theory.
attractive
investment
alternative for many institutional investors not so much
to earn
higher returns but to
portfolio and
noted
limit the
earlier,
diversification.
that
and
ERISA
risk in their
reinforced
Research has
included other
the
portfolios.
As
importance
of
shown that
a portfolio
investments including
real estate
foreign securities
strictly invested
properly diversify their
has
out-performed a
in equity securities.
portfolio
The following
chart demonstrates that a portfolio that was invested in
stocks, bonds, cash, real
much less
estate and foreign stocks was
volatile over time while
20
providing an almost
identical
return
data
Index
real estate and foreign
supports
the
that
belief
represents
securities.
through
a
500, T
to the S&P
is allocated equally
portfolio that
bonds, cash,
The BB&K
(4).
This
efficient
diversification risks in an
investment portfolio can be
limited and large swings in
the returns can be avoided.
It should also be noted that the BB&K Index outperformed
that
portfolios
real
excluded
foreign
and
estate
securities as investment strategies.
Year
S&P 500
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
4.01%
14.31
18.98
-14.66
-26.47
37.2
23.84
-7.18
6.56
18.44
32.42
-4.91
21.41
22.51
6.27
1987
1988
1989
5.23
16.81
31.49
-6.6
19.6
11.5
6.1
13.0
11.5
17.9
6.4
14.4
15.4
10.4
25.4
23.3
8.6
13.2
14.3
11.53%
11.55%
Theory has generally not
securities market
been applied
Many practitioners feel that
because real estate markets differ
Theory would
-2.2
18.47
to real estate portfolios.
the
4.7%
13.7
15.1
32.16
Compound Annual
Return
Modern Portfolio
BB&K INDEX
that to
apply Modern
be impractical and of
21
in so many ways from
Portfolio
little value.
Real
transactions
considerable
involve
typically
amount
complex
transactions
are
of
time to
financial
happen
the
daily for new events.
take
negotiate
and
a
often
Securities
instantaneously
and
are
Information in the real estate
often inaccurate
securities markets
large,
structures.
almost
rather straight forward.
markets is
very
or stale.
flows
Information in
quickly
and is
updated
Real estate is not always liquid.
Securities markets are generally very liquid.
Many real
estate transactions are private.
Securities markets are
public
available
and
transaction.
to be
information
is
on
every
Real estate markets are considered by many
classic inefficient
markets.
real estate professionals feel
are inefficient
there is
In
addition, many
that because the markets
more opportunity than
in the
securities markets to earn an above market return.
estate
skills,
negotiating
financing structures
means for
Many
ability,
practitioners
sophisticated
and property management
creating additional
believe
Modern Portfolio Theory to
value in
that
the
Real
provide a
an investment.
application
of
real estate will inhibit the
process and drive down returns.
It
is
markets
true that
differ in
industry
real
many
matures and
increasing
appropriate
clear
estate
markets and
ways but
research is
as
securities
the real
done it
estate
is becoming
that
Modern
Portfolio
in managing
a real
estate portfolio.
22
Theory
is
As
the latter part of the
real estate portfolios grew over
1970s
and early
diversify
investment
their portfolios
Typically real
were done
The
1980s
in a
managers tended
rather naive
estate portfolios that
so by property type
property
types
to
manner.
were diversified
and geographic location.
included
industrial, office and retail.
apartment,
hotels,
The geographic locations
included the East, West, South and Midwest.
Geographic diversification may have
of the
four
been the most naive
strategies employed by portfolio
regions the
determined
within a
north, south,
in a
midwest and
rather arbitrary
region may only
managers.
manner.
The
west were
The
have had location
states
in common.
The relationship of these markets to each other were not
considered
in creating
information
there
is
the
no
regions
way
of
diversification strategy is effective.
and without
this
knowing
your
if
Research done by
Miles and McCue and Hartzell, Hekman and Miles concluded
that the benefits of diversifying by geographic location
were not readily identifiable
diversification
was so
and because the basis for
broad the
strategy had
little
value (5).
In 1987,
David Hartzell,
David G. Shulman
and Charles
Wurtzebach co-authored an article entitled "Refining the
Analysis
of
Income-Producing
Regional
Real
Estate"
Diversification
(6).
The
for
authors
redefine
the
economic
regions of
activity.
Mineral
states
economic
Midwest,
Extraction,
regions
on
were
Old South,
Northern California
Farm
and
Belt,
Southern
New England includes all of the New England
except
Fairfield
employment base
County in
is primarily high
education, business
Connecticut.
and medicine.
The labor
Winters are harsh.
Corridor includes
Fairfield County,
stretches to northern Virginia.
financial services
government is
a huge
The
technology, defense,
highly educated.
business,
States based
included; New England, Mid-Atlantic
Industrial
California.
United
Eight
identified and they
Corridor,
the
force is
The Mid-Atlantic
New York
City and
The employment base is
and the
government.
employer in Washington
The
D.C.
The
Old South stretches from Virginia to Florida and west to
Arkansas.
and
The employment base is military, construction
power
number
of
generating
lower
income
Industrial
Midwest
Mississippi
valleys.
industrial
facilities.
our country.
The
Canadian
The
boarder to
Texas.
California
It
large
and
base
The
upper
is
large
work force
is
bread basket of
region is Kansas
runs
from
also includes
the
Alaska.
producer of oil (energy) and also
business service
Northern
The
Extraction region
a
laborers.
employment
largest city in the
Mineral
is
Ohio
Farm Belt is the
The region is a large
has a
the
production facilities.
primarily union.. The
City.
non-union
includes
Its
There
and high technology
area
also
includes
base.
The
Washington,
Oregon
and
includes
northern
finance,
business,
The labor
resources.
The
Nevada.
employment
defense
and
natural
highly educated.
force is
base
The
Southern California region includes Arizona and Southern
Nevada.
It represent
an
important financial
center.
The region has a substantial number of manufacturing and
defense firms.
The data
a period
1973 to
from
included in their study covers
mid
1987
and encompasses
the
returns of over 200 properties in a market value in 1987
of more than $3 billion.
diversification is
The report concluded that when
done based
on economic
location as
opposed to geographic location, regional diversification
does
have benefits.
application of
This
study is
important in
Modern Portfolio Theory to
the
real estate.
More study is needed in this area but their work clearly
demonstrates
that when
scientific data
is applied
to
diversification, real benefits are derived.
Salomon
presented
Brothers
a
entitled, "Metropolitan Employment
Considerations"
Portfolio
(7).
report
May
in
1990
Trends: Analysis and
The
report
examines
trends in employment growth in each of the eight nations
and
attempts to
a
determining
Employment
with
if there
determine
correlation
growth will
the portfolio
provide
new
demand for
tell
the
manager
can
negatively correlated in terms
a method
the
between
information on
research
is
for
regions.
manager
real estate.
If
markets
are
which
of growth an appropriate
investment strategy can be
some
very interesting
developed.
observations.
The report makes
The
report notes
that regions tend to grow at the national average but it
is critical to isolate
The following
each region's local growth rate.
table summarizes the
correlation between
total employment changes in the eight nations, 1976-1989
(annual data).
NEG MAC IMW SOU FMB MEX NCA SCA
New England (NEG)
Mid Atlantic (MAC)
Industrial MW (IMW)
Old South (SOU)
Farm Belt (FMB)
Mineral Ext(MEX)
Northern CA (NCA)
Southern CA (SCA)
1
.88
.73
.86
.77
.42
.76
.81
1
.70
.97
.82
.27
.73
.86
1
.88
.96
.21
.84
.93
1
.89 1
.19 .20
1
.81 .86 .41
1
.90 .92 .38 .94
1
The employment changes in a region when related to other
regions
show
correlation.
for
The
the
and
part
report infers
national economy has a
economy
most
high
positive
this to mean
that the
strong influence over a region's
employment
correlation is not 1
a
growth.
The
fact
that
the
indicates that the local economies
play a role in the growth of the region.
The
report
regional
then
examined
employment
industry mix effects.
the
growth
The
correlations
excluding
between
national
table below summarizes these
correlations:
NEG MAC IMW SOU FMB MEX NCA SCA
New England (NEG)
Mid Atlantic (MAC)
Industrial MW (IMW)
and
1
.64 1
-.45-.27
26
1
Old South (SOU)
Farm Belt (FMB)
Mineral Ext(MEX)
Northern CA (NCA)
Southern CA (SCA)
.65 .81 .05
1
-.22-.18 .63 .13 1
.27 .29-.73-.14-.64 1
-.14-.44-.29-.35-.09 .07
-.07-.31 .25 .01 .24-.18
that
results indicate
The
and
would mean
economic
diversification
For
positive
This
correlations.
portfolio manager.
and
significant
negative
mean
a
This would
England.
regions
in
move
opposite
the northeast
in
grows
as employment
directions,
to
example, the industrial midwest
economic
these
that
that regional
some benefit
provides
negative correlation to New
has a
1
certain situations
are
there
regions
between
in
1
.52
it
falls in the midwest, as employment grows in the midwest
it
falls in
the northeast.
funds in
place
An investor
may want
in their
both regions
properties from
to
portfolio to obtain a proper balance and efficiency.
The
Salomon
clearly
report
diversification strategies can
demonstrates the powerful influence
national economy on regions.
harmony
in
move
portfolio
limit a portfolio's risk
with
The
in region-specific factors.
resulting from changes
report also
regional
that
indicates
with
only
the
of the
Regional economies tend to
national
economy.
In
a
U.S. properties
this
remains
a
in
this
period
of
substantial risk.
It
is
interesting
difficult
economic
to
note that
times,
that
many
real
estate
portfolio managers have tagen no steps to diversify away
27
the risk of the U.S.
economy.
If the U.S enters into a
recessionary period all property returns will fall.
INTERNATIONAL DIVERSIFICATION STRATEGIES IN REAL ESTATE
From the research described above several very important
conclusions can be drawn.
1. Modern
They are as follows:
portfolio theory should be
used in managing
an investment portfolio of real estate.
competition
investors,
will be
grows
for
the
the application
required.
funds
In fact, as the
of
of Modern
Investment
institutional
Portfolio Theory
managers will
need this
information to support their investment decisions.
2. Real
estate represents
inflation.
Real estate
an effective
tends to
hedge against
move in
an opposite
direction from the stock market and therefore represents
an
excellent
institutional
diversification
investor.
investment portfolio
Including
strategy
real
for
estate in
should reduce the volatility
an
an
in a
portfolio while maintaining its overall return.
3. Foreign equities have been an effective means for an
instyitutional investor to
stocks.
U.S.
Many foreign
market in
have facilitated
diversify their portfolio of
markets have
recent years.
out performed
Advances in
the transfer of information
markets and increased
the
technology
among all
tremendously the opportunities in
international trade.
4.
A real
estate portfolio
economic region
will minimize
factors.
in the U.S.
should be
diversified by
Diversification
a portfolio's exposure to
A portfolio
invested
by region
local economic
entirely
in U.S
will
still bear the risk of our national economy.
In recent
has
months the
increased
interest in European
dramatically.
international real estate at
very
appropriate.
markets is done
Investing
money
in
first glance appears to be
Trading
in
international
daily and research shows that
effective diversification
above foreign
real estate
strategy.
In fact,
stock markets have earned
equity
it is an
as noted
higher returns
than the U.S. stock market.
Research indicates that
regions will
It
minimize risk in a
would seem
throughout
volatilty
economy is
the trade
crisis.
investing in different economic
that
the world
in
your
investing
real estate portfolio.
in different
would further
real estate
sagging and there is
portfolio.
risk of
The
U.S.
much concern regarding
deficit, budget deficit and
Other economies
limit the
economies
savings and loan
throughout the
world may
be
poised for prosperity and growth.
It is interesting since international opportunities seem
so logical that so many
in the real estate industry are
resisting the idea of
investing in foreign markets.
In
"Emerging
Trends
Real
by
Equitable
Real Estate
In
Estate (8); most of
believed
Europe
development
cite
of
limited
overseas.
bias
investment.
to be
Real estate
legal
and politics
overcome
in
as
venturing
too many obstacles
there
appears
industry
has been
foreign
practices,
information
the
are
Industry professionals
business
addition,
in
18% felt there
these markets
feel there are just
In
U.S.
overseas
language barriers,
unusual
obstacles
overcome.
Real
for
interest in
Many feel
poor market
Many
built-in
potential
believed
are full of peril.
the
prepared
with RERC
fad with no potential and
issues,
constraints,
some
conjunction
cultural differences,
currency
to
offered
excellent potential.
unknown and
1990"
the developers they interviewed 56%
firms, 26%
markets was a
is
in
Estate
against
to
be
a
foreign
considered to
be a
local business and in tough times there is a tendency of
industry professionals
know the
best.
to retreat
to the
Many industry professionals
markets they
shudder at
the thought of going into foreign markets.
These
arguments seem
very weak
when you
consider the
tremendous investments made by U.S. companies in foreign
lands.
In travelling the world
you will often see U.S.
companies with facilities overseas.
factory overseas
or buying
Certainly opening a
a company
involves dealing
In just the past
with all of the obstacles noted above.
year there have been several significant acquisitions by
U.S
in
firms
invested heavily
markets including
properties in most major
have bought
City and ski resorts in
Rockerfeller Center in New York
Japanese companies have been
Many British and
Vermont.
and the Japanese
invested in the U.S
Dutch are heavily
in
decades.
The
of
hesitancy
to
firms
U.S.
for
world
the
throughout
estate
real
investing
The
market.
U.S. real estate
in the
also
have
countries
Foreign
Europe.
explore
opportunities in foreign countries seems unreasonable.
The
in
industry
estate
real
with it a new focus
institutional investors has brought
research
market.
and
needs
the
In addition,
decisions are
The
business
business
for
a
from
see if it will grow to
U.S.
Their
to
a
We will have
be an international
It already
firms.
of criteria.
local business
national business.
regional business to a
to wait and
a different set
made using
has grown
institutional
of an
from an individual.
investor are quite different
the
of
dynamics
the
understanding
grow
The involvement of
tremendously over the past 15 years.
on
has
U.S.
the
is
most
for
foreign owned real estate firms.
Modern
Portfolio
Theory
certainly
investigating opportunities in
extent
an investor
can
find
would
foreign markets.
support
To the
suitable investments
in
countries
that
(zero
negative
or
should be
address
made.
the
have
different
economic
correlation)
The next
obstacles
fundamentals
foreign
investments
section of this
thesis will
that
will
be
implementing such an investment strategy.
encountered
in
***SECTION II***
INVESTING IN FOREIGN REAL ESTATE
real estate
American real
estate investors.
investors
U.S.
require
to minimize the additional
important for
strategies
develop
access
their
limit
for
to
risks that may be associated
It will be
located in foreign lands.
mind that
to keep in
American investors
bring with
they may
challenges will
These
In addition, investors will need
international markets.
with real estate
to
that
obstacles
overcoming
challenges for
presents new
International
them a predisposition
to failure.
Many of the things that have been discussed above may be
as
used
excuses
investment
of
strategy regardless
international
an
rejecting
for
how intriguing
the
opportunities may appear.
One
of
the first
obstacles
investors is bridging the
to
be overcome
cultural gap.
by
U.S.
A cultural gap
can mean many things, it can describe differences in the
way
their
and
people
dress,
attitude toward
their
their
their customs,
family, their
understanding
of
motivations,
religious beliefs
property
ownership.
Understanding these cultural differences is critical for
two
reasons in
first reason
patterns
making a
is cultural differences
which will
estate product.
role in
real estate
determine
the demand
for a
an office building,
worker.
The
affect behavioral
The expectation of workers
the design of
and space per
investment.
real
can play a
the quality
The social pattern
of a country
and the composition of a family unit can impact the size
and
number of
second reason
estate
bedrooms in
cultural differences
transaction
property.
an apartment
is
in
intense negotiations
that can take several
of these negotiations
can
barriers
The
a real
purchase
estate transactions
the process
create
will impact
the actual
Generally real
complex.
of
a
require
months.
In
cultural differences
to communication
and
closing
a
successful deal.
The world we live in is quickly changing.
trade and advances in
some
extent the
This
thesis is
Europe.
The
the same
International
communications have diminished to
implications of
focusing
on
cultural differences.
opportunities in
people of Western Europe
products Americans
Western
purchase many of
do, buy the
same clothes,
drive the same cars, watch the same television shows and
movies and
travel to
people in
the U.S.
many of
Western Europe
the same
have studied or
The cultural gap
resorts.
Many
travelled in
between the U.S. and Western
Europe is shrinking rapidly but cultural differences may
still
play
a role
in
real
34
estate transactions.
An
investor by limiting their investment scope to countries
with
and
brokers
correct
the
based in
economies
and by
west
consultants
can
using
the
this
overcome
obstacle.
Language barriers are often cited
as an obstacle for an
investor attempting to enter a foreign market.
no doubt
that if
business will
is also
you do not
speak the
be more difficult.
one that is commonly
business
circles.
Many
The
There is
language doing
language barrier
overcome in international
U.S.
companies
do
business
overseas and many foreign based companies do business in
the
U.S.
A first
step
for
business overseas would be to
country they have targeted.
hire
real estate
language of
is an
are fluent
There
in the
are also
It
to American businessmen.
that in most of
acceptable language
do
Another option would be to
and English.
many translators available
to
learn the language of the
professionals who
that country
should be noted
anyone intending
Western Europe English
for doing business
and many
people speak the language.
Political unrest
be
nationalized
catastrophic
loss.
developed countries
unlikely.
Since
of Americans investing
it possible that your holdings
After all isn't
abroad.
could
is also a fear
leaving
This
would
the
be
investor
a
but in Western Europe
this thesis
is focused
risk
with
in
a
less
it is highly
on investment
opportunities
in Western
Europe we
will not
consider
political unrest to be a major concern.
Understanding the
real estate in
property laws and rights
a country is essential
investment strategy.
Real estate
developed over a long period
complex.
(9),
It is interesting to note that real estate law
The
systems are
three
United
basic
and
classifications
in
many
law
satellite
countries.
is practiced
by early
countries,
for
rights under the
property
firms
now have
is
The Western
their
ownership,
then
European
distinctive
clear title
law is essential.
36
great concern to
and
knowing
With
during the past 15
offices in
leaseholds,
law can differ between
this an area of
Having
international trade
law
its
Romano-Germanic legal systems." The
Obviously
investor.
U.S.S.R. and
each have
landlord-tenant law and contract
an
countries
countries who were particularly
example,
regarding
the
the United States.
the
Roman Law.
legal variations of
legal
England, most of
Romano-Germanic
practiced in most other
influenced
in
of
and Socialist.
of
the United Kingdom and
Socialist
countries.
Property Investment"
system is practiced in
States,
dominated by
laws
As Mary Alice Hines noted
Romano-Germanic, Common Law
The Common Law
the
laws like others were
book "International Income
"
in developing an
of time and are often very
can vary by state in the U.S.
in her
relating to
their
the growth of
years, many law
cities outside
the U.S
or
affiliations with
An
with a
establish a relationship
need to
investor will
countries.
in foreign
law firms
firm in the country they have targeted for investment to
learn the nuances of their laws.
the success of a transaction.
have a dramatic impact on
For
instance,
dollar
dollars to buy
the
was
property
if a
that the
purchased when
the foreign
weak against
was very
require
would
value of currency can
Fluctuations in the
commodities.
investor
If
amount
currency to close
investor
the
the
currency it
a large
use
enough of the foreign
transaction.
like
now traded
are
world
throughout the
Currencies
then
sells
the
in the foreign currency but
property for the same price
the dollar has strengthened when the foreign currency is
converted back
dollars and
considered
to dollars the investor
a loss.
will have incurred
a foreign
will have fewer
This
would be
The
translation loss.
currency
impact of fluctuations in foreign currency is of concern
to anyone investing overseas.
of two approaches
in dealing with the
The first
translation losses.
can only
be done
The investor can take one
if you are
risk of currency
This
is to ignore them.
reasonably sure
that you
will not be required to bring the funds back to the U.S.
If you
at a time when the exchange rate is unfavorable.
choose
this approach
you
have elected
to place
funds in a foreign market for an indefinite period.
second
option
is to
employ
a
specialist in
your
The
foreign
currencies who
investment.
can devise
a hedging strategy
Hedging strategies
and limit the
for your
are employed frequently
risk of any currency
exposure.
The cost
of the hedging strategy will be born by the investment.
One of the more
significant issues relates to taxation.
Each country has its own
must
understand
investment.
how
tax structure and the investor
that
tax
For instance in
exempt
from taxation.
income
of
the
principle
are
being
beneficiary/retiree
receives the
the
is
pension
savings.
fund
that
being that
deferred
until
benefit.
In
individual's
may not be tax exempt.
substantial influence on the
country.
The
"big
offices overseas.
whatever
investment.
investor
their
the
the
essence
retirement
In certain foreign countries the income earned
by the funds
with
i'mpacts
the U.S. pension funds are
The
fund
law
could have a
decision to invest in that
accounting
firms
all
have
These firms could provide an investor
information
In addition,
in their
these firms
six"
This
tax
may also be
contacts and information.
they
need
these firms
planning.
regarding
can assist
The individuals
a valuable source
an
the
in
of business
***SECTION III***
THE CHANGING LANDSCAPE IN EUROPE
Many in the U.S. have
been watching with great interest
the activities of the
European Community.
at
and many obstacles will have to
such a plan is enormous
be
but it
overcome
are
member nations
that
appears
the establishment
committed to
of implementing
The task
1992.
December of
market by
The
fully integrated
for a
1985 calls
adopted in
program
market-economy.
single integrated
a
forming
12 Member Nations
been working with its
Commission has
The European
of a
single integrated
The GDP, once the nations are combined, will be
market.
slightly less than that of the U.S.
fact, The
objective of
described
in the
Community
shall have
common
economic
single common market
Treaty
and
market
policies
as
its task,
of
Member
a
was first
1957 (10);
in
of Rome
progressively
the Community
throughout
In
European market is not new.
The concept of a single
"The
by establishing
approximating
States,
to
a
the
promote
harmonious development
of
economic activities, a continued and balanced expansion,
an
increase in
standard
of
stability, accelerated
living
and clear
raising of
the
between
the
relations
states belonging to it."
The Treaty
of Paris in 1951
and the Treaty of
Rome in
1957 established the three initial European Communities;
the European Coal and Steel Community, the Atomic Energy
Community
and the
European Economic
Community.
These
organizations were combined in 1967 to form the European
Community.
Their goals were
summarized in "1992 Single
European Market" as follows (11):
1. To lay
the foundation for a closer
union among the
peoples of Europe.
2. To establish
a common market by
the elimination of
trade barriers.
3. To work
for the constant improvement
in living and
working conditions throughout Europe.
were
There
France,
Italy.
and
originally
six
West Germany,
In
in
Luxenbourg, the
1972, Denmark,
1981
Greece
member
nations
Netherlands and
Ireland and the
was
added,
in
Belgium,
1986
U.K. joined
Spain
and
Portugal.
In 1985, the European
for
creating a
program
this
Commission released their program
fully integrated
described specific
goal and
proposed
market by
steps necessary
timetable for
1992.
The
to achieve
implementation.
The program was adopted and the Commission is now in the
The objectives set
internal market.
barriers to a free
fiscal
and
technical
physical,
the
all
eliminate
to
required
measures
the
implementing
of
process
out in the Treaty of Rome more than 30 years ago are now
rapidly approaching fruition.
The process in getting to
this point may have been painfully slow at times but the
objectives.
achieving their
be in
benefits that
could
population that is
when combined have a
Member Nations
larger than the U.S. and double that of Japan.
The U.S.
The EEC's
million square miles.
markets cover some 3.6
The
economy.
and
integrated market
an
from
result
This dedication may
the tremendous
motivated by
part
to
dedicated
remain
Commission
the
and
Community
markets cover 870,000 square miles and most of the major
been
have
economies.
The
handicapped
in
integrated markets of the
believes that
Commission
bring
that
industries
reduction
to
in
This
were
European markets-economies
with
competing
an
integrated market
the
should
its
industries in
competition, particularly in
protected,
profit margins
and
should
the
pressure on margins should
increase their
fully
the
The European
U.S. and Japan.
scale to
Increased
Member Nations.
goods.
of
an economy
of these
have hampered the growth
These inefficiencies
markets and
great inefficiencies.
have been
this there
because of
and
the past
in
independently
have operated
markets
These
hundred miles of Paris.
markets are within a few
efficiency to
41
lead
price of
to
a
these
motivate firms
protect these
profit
margins.
of
Competition
goods and
process.
should also increase
stimulate
innovation
The Commission
1985 estimated
in its
the gains
in the
the quality
production
program statement
that would result
in
from these
improvements in the manner of doing business (12):
1. Add, on average, 5.3% to the Community GDP
2. Deflate consumer prices by an average of 6.1%
3 . Improve the balance of
public finance by an average
equivalent to 2.2% of GDP.
4. Improve
the EEC's trade position
by the equivalent
of around 1% of GDP
5. Boost employment by 1.8
million new jobs, though in
the short term unemployment
will be unaffected.
In the
longer term, it should fall by 1.5%
As outlined in the
Euromonitor publication "1992 Single
European Market" there are a number of costs incurred do
the
segregation of
the European
markets (13).
These
additional expenses are summarized below:
1. Administrative
costs
incurred
in
dealing
with
different national bureaucratic regimes
2. Higher transport
costs
related to
border-customs
formalities
3. Increased costs
different
national
resulting
standards
production runs
42
from the
which
need to
require
meet
smaller
separate
by
incurred
costs
of
duplication
4. The
production runs
heavily
government
as
such
activities
national
regulated
non-competitive and
of
costs
5. The higher
procurement
Commission
European
The
program
their
implementing
At the present time,
unissued
at times
empowered
been
to
(14).
Directives
complex and
reach a
the
All
Commission will
but it does
obviously
Commission has
has
been made
objectives of
to
the
Eastern Europe, the consolidation of
the politics
and
Germany
the
It is also likely that
Commission will not be achieved.
with the events in
is
The process
investment
and the
on
consensus
difficult but the
these markets.
integrate
issued and committees
of these have been
established
been
have
of
their
integrate
to fully
Member Nations' markets-economies.
more than 100
the *process
in
Directives
400
approximately
issue
to
expected
is
its
of
Member Nations
not meet its deadline
the
of December 1992
appear that the considering
the history of
this endeavor, the momentum it has now and the work that
has been
It is
done it will
interesting to note that
its commitment
to the EEC.
reunified Germany
of
the
regardless
European
of the
near future.
be achieved in the
Germany has reconfirmed
Many are concerned
will threaten the success
Commission.
impact
of a
Others
that a
and future
believe
reunified Germany
that
the
events
in eastern
accelerate the
going to
Europe are
informal integration of the markets-economies of Europe.
The
reconstruction of
tremendous
amount of
alone will
need close to
Germany.
for
a
The Germans
$300 billion to
rebuild East
All Eastern European countries will be anxious
Europe as
attractive to
the
will require
foreign investment.
foreign investment.
Eastern
Europe
eastern
In addition,
well
as the
Western Europe.
European Commission
labor
the markets
force are
The momentum
toward a
of
very
started by
more integrated
and
freer economy will continue and grow stronger as Eastern
Europe opens up.
The benefits of a
common market, the
need for capital
and the demand for
goods and services
are simply
to great for
any member nation to
stand in
the way.
In terms
of real estate
have great importance.
are to
improve
strategy the events
The objectives of the Commission
promote economic
the
growth, expand
overall quality
of
objectives should also increase
life.
to predict when the impact
All of
these
It is impossible
of an integrated market will
Europe but it is safe to
the U.S.
struggles to
deal with
deficits
Europe seems
poised for
economies.
employment and
interest in real estate
and stimulate the real estate markets.
be realized in
in Europe
say that while
its trade
and budget
an expansion
in its
may
Europe
any
reduce
in Europe.
diversification
The
properties.
portfolio of
European
acquiring
strategy involving
diversification
a
manager looking
for an investment
interesting question
at
also pose an
of the European Commission
The activities
Member Nations may react as
integration of
regional
a
of
benefit
the
economies of
All the
a
one or have a very positive
correlation.
OVERVIEW OF ECONOMIC PERFORMANCE IN WESTERN EUROPE
As
noted
was
consider
in
relationship-correlation
of
must
strategy
assessing opportunities
markets
the U.S.
markets in
estate
terms of a diversification
the
U.S.
in a
foreign markets
the
of
an
portfolio.
In
markets of
real estate
in the
perform in
will
manner
performance
the
first understand how
it is essential to
Western Europe
these
scientific
a
other investments
investment with
diversification
"efficient"
an
above,
to
relationship
The greatest
real
benefits in
strategy will be achieved if
are negatively
correlated to
the
is essential in any international
In addition, it
diversification strategy to understand the relationships
between
all the
countries-investments
in a
portfolio
with each other.
The economic performance of
impact on
economic
its real
a country has a significant
estate markets.
expansion and
employment
During a
growth a
time of
country's
real
estate
markets
correlation matrices
between the U.S.,
Spain
when
will
be
stimulated.
below summarize
U.K.,
comparing
also
The
the relationships
France, West Germany, Italy and
the
annual growth
in
GDP
and
employment.
CORRELATION MATRIX- GDP GROWTH, 1970-1989
U.S.
U.K.
U.S.
1
.40
.36
.56
.14
.31
U.K.
.40
1
.39
.56
.40
.42
FRANCE
.36
.39
1
.77
.69
.64
W. GERM.
.56
.56
.77
1
.79
.47
ITALY
.14
.40
.69
.64
1
.43
SPAIN
.31
.42
.64
.47
.43
1
FRANCE W.GERM ITALY SPAIN
CORRELATION MATRIX- EMPLOYMENT GROWTH 1970-1989
U.S.
U.K.
FRANCE W.GERM ITALY SPAIN
U.S.
1
.35
.12
.44
.19
.04
U.K.
.35
1
.35
.39
.21
.34
FRANCE
.12
.35
1
.37
.12
.47
W. GERM.
.44
.39
.37
1
.04
.24
ITALY
.19
.21
.12
.04
1
.05
SPAIN
.04
.34
.47
.24
.05
1
The results indicate that the
influence on
many of
U.S. economy has a strong
the economies of
Western Europe.
This is not surprising when you consider the size of the
U.S. economy and the depth
countries in Western
of its markets.
Many of the
Europe export a great
deal to the
depend on these markets.
U.S. and their industries
will tend
Western Europe
economies of
same direction as the U.S. but
has the
and
coefficients
appear
influence on
be
to
though
events specific
status
not to same degree or as
positive
to a
market
least
clearly
dependent.
The
indicate
that
particular country have
its economy.
of each
the
West Germany
U.S. while Spain
strongest relationship to the
Italy
For this
must be
making an investment decision.
47
in the
to move
indicate that
results also
The
quickly.
The
a strong
reason the current
carefully reviewed
in
The
events
assessing
in
an
Europe
must
international
also
be
diversification
The actions
of the European Commission
in
Europe
Eastern
should enhance
growth in Western Europe.
that make the
that
include
events
data
such as
strategy.
potential
for
It is precisely these changes
investors.
the historical
in
and the changes
the
real estate markets of
appealing to U.S
considered
Western Europe so
It should be
used in
this.
the
The
kept in mind
study did
benefits of
not
this
growth will have an impact on the real estate markets in
the U.S. but obviously to
lesser degree than in Western
Europe.
The results also indicate
that the economies of Western
Europe tend to move in the same direction.
and France seem
to have the strongest
direction of the economies
West Germany
influence on the
in Western Europe.
The fact
that these correlations are not 1 indicates that country
specific
factors
play
a
significant
role
in
the
prospects of a particular market.
Additional study is needed but it appears there would be
a benefit to
an institutional investor in
investing in
the real estate markets of Western Europe.
REAL ESTATE MARKETS IN WESTERN EUROPE
Many
were useful
Saunders (15)
of
markets
western
the
can be
information
at the
and
others
firms
These
Europe.
There
world.
foreign as well as
information on
markets
resources in looking
and annual reports
publish quarterly
throughout
and Baker, Harris
Healy & Barker (14)
Counselors (13),
markets
estate
particular, Landauer Real Estate
In
throughout Europe.
their
provide
firms
real
on
information
with
clients
estate
real
international
In
no
that
doubt
domestic real estate
there is
improved but
available.
is
regarding markets
addition,
reasonably good
been
there have
many books written on international trade and several on
investing in foreign real estate.
In selecting a foreign market for real estate investment
critical that
it is
fundamental
year
strength of
the Economic
Survey of
Economic
amount
of
an understanding
you have
the
of
Europe that
on
Each
country's economy.
Commission
information
of the
the
Europe publishes
provides a
current
an
tremendous
status
and
prospects for each country's economy.
The United
Kingdom's real
are similar to the current
in the
U.S.
center
and is
market.
The
London is a
also
estate markets in
many ways
state of real estate markets
major international financial
the U.K.'s
principal real
London market, like the
estate
U.S., is burdened
by concerns about the health of the nation's economy and
an excess
boom in
the
supply of inventory created
the late
U.K. will
1980s.
by a development
Current predictions
experience an
inflation rate
are that
of better
than 7% in 1990.
In
sharply in 1989.
Most believe this will dampen economic
growth in
estate.
demand
The
addition, short term interest rose
the short term
The
office sector
resulting from
demand for
result of
retail space
The
considered to be overbuilt
of new space due to come
investors
in
U.K.
developing
the Canary
Randsworth
Trust a
holdings
in
purchased
Japanese
the
about
and
the economy.
slackened as
a
The industrial
economic news demand
retail
on line.
are
It is interesting to
investors
have
property.
Olympia
been
Wharf project
U.K.
sectors
and have significant amounts
real estate
3.1
in
in 1989 but as companies tighten
office
overseas
for real
a reduction
spending.
light of the gloomy
drop.
that
seen
has also
a drop in consumer
their belt in
note
has
concerns regarding
market had a good year
should
and also the demand
In
and
firm with
1989,
York
and JMB
of
real
investors were
are
bought a
significant
foreign
billion pounds
and Scandanavian
significant
investors
estate.
particularly
active.
The economy of
France appears to be
quite strong.
The
nation's GDP grew by 3.2% in 1989 and inflation was kept
relatively in check at
real estate
3.6%.
Paris is France's primary
market though other city's
50
and regions are
expanding economy and
a result of the
seeing growth as
in 1992.
the integration of Europe
anticipation of
majority of the EEC's combined
was noted earlier that a
In addition,
market lies in a 400 mile radius of Paris.
In the last
three years there has
development
in Paris
inner
suburbs the
but in
been in
city and
the center
strong and
systems.
the
supply
of the new development has
served by
suburbs, especially those
the outer
transportation
been significant new
has been
demand
A substantial amount
tight.
performer in 1989.
Paris was a strong
office market in
The
world.
of the
great city's
of the
is one
Paris
It
The
interest
estate
in real
markets outside Paris has been spurred by the arrival of
The
Channel Tunnel Project.
speed train and the
a new high
returns
on
properties
office
have
been
under
pressure due intense competition for the properties.
seems that
office building.
been
active in
The Japanese, Swedish and
the France's
a French
seeking to buy
almost everyone is
real estate
It
Dutch have
markets.
In
addition, other Member Nations of the European Community
have
been acquiring
property.
The
Paris was strong for prime locations.
in general has been driven
robust level of private
retail market
in
The retail market
by the healthy economy and a
consumption.
It is interesting
to note that out of town shopping centers, hypermarkets,
are
becoming an
shopper.
important convenience
Industrial development
French
has occurred primarily
outside of Paris and in smaller cities.
51
for the
Demand has been
strong for
industrial space and rents
have been moving
upward.
Germany
may be
the most
interesting of
estate markets in Europe.
and
West Germany
all the
real
The impact of reuniting East
is staggering.
The investment
that
will be required to rebuild East Germany is estimated to
be as much as $300
predict
billion.
the impact
It is almost impossible to
this will
have on
Germany or on its real estate markets.
to
open its
borders
to foreign
invest in their future.
The
the economy
of
Germany may need
investors seeking
to
West German economy put in
a strong performance in 1989.
The country's GDP rose by
3.9% and inflation though it increased substantially was
only 3.2%.
retail
large
All of Germany's real estate sectors office,
and industrial
extent
economy.
attributable
Foreigners
real estate
markets.
funds invested
The
many
lack of
of
did well
in 1989.
to
the
are starting
In 1989,
strength
to invest
these
investors
to
properties has
place
their
The approval process
is
limits
which
competition for properties is
supply.
intense.
to
its
in German
of the
were foreign.
development projects.
difficult
of
about one third
in commercial real estate
investment grade
This is
In
prompted
money
in
in Germany
addition,
The West German
economy is one of the strongest in the world but it will
be under
East
tremendous pressure
Berlin.
This
could be
in attempting
a unique
to rebuild
opportunity for
foreign investors to buy German real estate.
2.8%, but
increased by
is now running at 6.5%.
The
locations.
Stringent standards for
limit
supply
the
in most major
retail market
downtown
m6st
in
cities is
In addition to restrictions on new development,
strong.
retail associations also
of new
the amount
was
in 1989 and
The office markets in the major
cities of Italy are very tight.
development
than in
was slower
the growth
The inflation rate increased
prior years.
new
The country's GDP
economy slowed in 1989.
The Italian
have considerable influence on
space built.
1989.
performer in
strong
industrial sector
The
are high
Prices
and
opportunities are limited for foreign investors.
The
GDP
of
benefited
Spain
grew
greatly from
The
4.9%.
by
economy
with the
its affiliation
The inflow of foreign capital has been significant.
large well educated work
have proven to be
Unemployment
real
concern but
all
will continue to grow.
The
remain
in Spain
market
performance in all sectors of
have been strong.
other cities
Valencia.
The
very attractive to foreign investors.
and inflation
estate
EEC.
force and relatively low wages
indications are the economy
major
has
As the
has grown,
a
is
Madrid.
The
the real market in Madrid
economy has grown interest in
particularly in
Barcelona and
CONCLUSION
This
thesis
addresses
the
appropriateness
international diversification
The
study was
done
institutional
volatility
estate
from the
investor
in their
overall return.
strategy in
portfolio while
In addition,
markets in
to
an
real estate.
perspective
seeking
of
of a
large
minimize
the
maintaining their
the current state of real
Western Europe
this research three important
was explored.
From
conclusions can be drawn.
They are as follows:
1.
Investing
in foreign
appropriate strategy
is
managing
Theory.
their
Efficient
shown that
estate
markets is
for an institutional
portfolio
using
diversification
Modern Portfolio Theory.
have
real
investor who
Modern
is
an
the
Portfolio
basis
of
Historical investment results
diversification
economic region in the U.S.
by
product type
and
has reduced volatility in a
real estate portfolio while maintaining overall returns.
Economic diversification in the
of region specific economic
demonstrated
significant
country.
the
effect
changes.
economic health
on
A strategy that
markets would
U.S. reduces the impact
all
of
economic
Research has also
the
U.S. has
regions
of
a
the
involves investing in foreign
reduce the impact a
recession would have
on
a portfolio
of
real estate
investments which
are
entirely located in the United States.
2. Many
will
changes are now
have
a significant
Western Europe.
the European
real estate
These
on
of
markets
changes
should
be
in
to differing degrees.
the
state
of
economies in the U.S.,
be in
in
all
of
be
events
economic
will
be
study reviewed
estate
markets
health with
of
and
these
markets
very
A strategy which
near term.
different prospects in the
invests
country
The
the
Each of these markets appears
different states
very
strong
the United Kingdom, France, West
Germany, Italy and Spain.
to
real
the
how these
Each
was
could
opportunity for
enhanced.
a
Europe that
Europe
will tell
affected but
current
investing in
such
Western
within
but the
markets of
Western Europe
will have
of
Only time
reshape Europe
of
that are taking
The benefit of
diversifying
insignificant.
growth
integration of the
the economies
benefits
the countries
Community and the changes
considered.
will
by the
on
Europe which
direction of Europe will be
Eastern Europe.
different
impact
effect
The future
greatly impacted
place in
taking place in
would
seem
most
appropriate.
3.
Many
U.S.
opportunities
firms
in foreign
are
reluctant
markets,
cited and risks are discussed
55
to
explore
many obstacles
are
but these are by no means
insurmountable.
U.S. real estate
There
are many resources
available to
investors seeking foreign investments.
An institutional investor should
not be deterred by the
biases of the real estate community.
56
END NOTES
SECTION I
1. Stephen A. Pyhrr, James R. Cooper, Larry E.
Wofford, Stephen D. Kapplin, Paul D. Lapides, "Real
Estate Investment Strategy Analysis Decisions", Second
Addition 1989, page 638.
2. Randall C. Zisler," Stock and Bond Market
Volatility and Real Estate's Allocation", Goldman Sachs,
November 16, 1987, page 3.
3. David Hartzell, John S. Hekman, Mike E. Miles,
"Real Estate Returns and Inflation", AREUEA Journal,
Vol. No. 1, 1987.
4. Tom Herman, "What Wall Street's First Rule?
Diversify", Wall Street Journal, January 25, 1990.
5. David J. Hartzell, David G. Shulman, Charles H
Wurtzbach, "Refining The Analysis Of Regional
Diversification For Income-Producing Real Estate", The
Journal Of Real Estate Research, December 1987, page 85.
6. ibid, pp 85-90
7. Bond Market Research, Real Estate Solomon Brothers,
"Metropolitan Employment Trends: Analysis and Portfolio
Considerations", May 14,1990, pp. 7 & 8.
8. Real Estate Research Corporation, "Emerging Trends
In Real Estate: 1990", pp 40 & 41.
Section II
9. Mary Alice Hines, "International Income Property
Investment", International Institute, 1984, pp 27 & 28.
Section III
10. Euromoitor, "1992 Single European Community", 1988
p.17.
11. ibid., p. 7.
12. ibid., p. 42.
13. ibid., p. 81.
14. Mary Alice Hines, "EC 1992: Challenges To
Integration", Real Estate Finance, Vol. 6 No.
46.
2, page
BIBLIOGRAPHY
1.
Landauer Real Estate Counselors,
"
International
Property Bulletin, 1990 ".
2. Mary Alice Hines, "International Income Property
Investment, International Institute, 1984.
3. Mary Alice Hines, Guide To International Real
Estate Investment, Quorum Books, 1988.
4. Dudley S. Hinds, Nicholas Ordway, "International
Real Estate Investment", Real Estate Education Company,
1983.
5. Bill Javetski, Rose Brady, "Eastern Europe: A New
Economic Miracle", Business Week, November 27, 1989.
6. Bill Javetski, John Templeman, "One Germany: The
Whole European Equation Has Changed", April 2, 1990.
7.
Euromonitor, "1992 Single European Market", 1988.
8. Mary Alice Hines, "EC 1992: Challenges To
Integration", Real Estate Finance, Summer 1989 Vol.
No. 2.
6
9. Baker Harris Saunders, "The Capital's Property An
Introduction To The London Office Market".
10. Economic Commission For Europe, "Economic Survey
Of Europe In 1988-1989", 1989.
11. Nick Baucher, Sandra Jones, "World Watch: The
London Office Markets", Real Estate Finance, Fall 1989
Vol. 6 No. 3.
12. Real Estate Research Corporation, "Emerging Trends
In Real Estate: 1990, Otober 1989.
13. Healy & Baker Research, European Network Property
Report, 1992 The single Market", 1989.
14. Healy & Baker Research, "Main Streets Across The
World, Winter 1989-1990", 1989.
15. Healy and Baker Research, "Prime: Property Rent
Indices and Market Editorial" 1990.