The growth and performance of international public real estate markets. (Journal of Real Estate Portfolio Management).

Executive Summary. This paper looks at the growth in size of public capital markets around the world and analyzes the returns that have been achieved. Monthly data from Global Property Research (GPR) for periods 1984 through 2002 mid year is used for the study. The paper describes the number of firms and market capitalization found in 16 countries then examines the return correlations of the major real estate indices around the world along with their growth and performance. We conclude that while the reasonable returns and low correlations of most public real estate markets around the world should attract institutional investors, but the relatively small size of most markets has made them less attractive. The U.S. market cap is $170 billion; but all other markets are much smaller with France, Hong Kong, and Japan averaging around $40 billion being the next closest tier. Thus the public real estate markets around the world still have a long way to go and grow to attract significant institutional capital.

I. INTRODUCTION:

Access to capital is a major component of every real estate investment decision and access to public capital markets has been a major problem for capital hungry real estate investors since the beginning of time. However, the last decade of the 1900s bought a new era of access for real estate to the public capital markets around the world. This paper looks at the growth in size of public capital markets around the world and analyzes the returns that have been achieved. We examine the growth and performance of public market real estate in an international context using monthly data from Global Property Research (GPR) for periods 1984 through 2002 midyear. With the poor performance of the general equity markets around the globe and the lowest interest rates in 50 years, many investors have decided to add to their real estate allocation in both private and public form investments. Another reason for investors to consider real estate is that there has been an increasing correlation between international stock and bond market return indices, causing investors to look for additional portfolio diversifiers. This paper also examines the return correlations of the major real estate indices around the world along with their growth and performance.

II. LITERATURE REVIEW

There is a vast literature that has examined the size, growth, and performance of the international debt and equity markets. Beginning with the seminal work of Solnik (1974), practitioners and academics have espoused international investing due to the low correlation in returns across countries, providing diversification opportunities. However, recent studies have suggested that due to the increasingly global, open economy, the cross listing of securities, and the rapidly advancing technology that international debt and equity markets are becoming more correlated, thus reducing the benefits of international diversification (Conover, Friday, and Sirmans, 2002).

On the domestic side, there are numerous studies that have examined the size, growth and performance of both public and private real estate investments. Like international debt and equity, real estate allocations have been advocated due to their low correlation with domestic stock and bond returns (Conner, Hess, and Liang, 2001). With the recent downturn in the general equities market, the increasing correlation of international stocks and bonds, and the relatively strong performance of real estate, investors are becoming increasingly interested in international real estate. However, there are very few studies that have examined the international real estate markets. Stevenson (2000) points out that few studies exist because there is relatively little data and the data that does exist is only for a limited number of countries.

In general, most of the international real estate studies that have been completed have tried to determine if international real estate investing provides diversification benefits. The majority of the studies find that international real estate has a role in a mixed asset global portfolio. However, none of these studies have used current data, with most data stopping in the mid to early 1990s. The latest study Gordon and Canter 1999, used a 14-year period through 1998 on 14 countries and found that high dividend paying companies (such as REITs) had lower correlations with their domestic stock markets. This is problematic as strong growth in public real estate occurred after this time frame. Additionally, the prior studies looked at only a handful of the largest countries. In the current study we are able to use data from 1984 to the present and examine three major regions--America, Europe, and Asia, and thirteen countries within each of these regions. This allows us to be able to ascertain, for the first time , if diversification exists between regions or within the individual countries in those regions. Moreover, we provide the first comprehensive study that examines return performance, return volatility, returns relative to risks, growth in the number of public real estate firms, growth in the market capitalization of the public real estate firms, in addition to their return cross correlations. The next section examines the evolution and development of the public real estate markets.

III. THE GROWTH AND DEVELOPMENT OF PUBLIC REAL ESTATE COMPANIES

There has been a dramatic increase in the number of public real estate firms across the globe in the last two decades. Exhibit 1 shows the change in the number of public real estate companies broken down into three major geographic regions around the world: America, Europe, and Asia. The trend line shows that Europe was first with the number of companies growing quickly in the late 1980s, flowed by the America region in the early 1990s and then the Asian region in the late 1990s. Note that the large jumps in both the European and American statistics are not due to a major change in one given year in the actual marketplace, but the addition of those companies to the GPR index in that given year as GPR developed their database (although the inclusions were lagged by only one or two years).

Analyzing the countries within the 3 geographic regions, we see that within America there are 4 countries with public markets. America started out with the fewest firms of any region and now, due to the growth of public real estate firms in the United States, has the largest number of firms (Exhibit 2). Mexico and Argentina have only a few companies and Canada has managed to grow to 20 companies, but the U.S. market dominates the Americas with over 150 companies.

Europe, France, and the UK have the largest number of public real estate companies. The UK experienced the majority of its growth in 1997 and 1998 but has lost firms since that time period. France, experienced rapid growth in the number of firms in 1989, remained steady for several years, and has been on a recent downward trend due to consolidation (Exhibit 3). All other countries have less than 10 firms.

Examining the number of public real estate firms in Asia reveals that Australia, Hong Kong, Japan, and Singapore have the largest number of finns. For the most part, the major increases occurred in the late 1980s and early 1990s while the number of firms fell in 2002 for all countries (Exhibit 4).

IV. TRENDS IN MARKET CAPITALIZATION

The trends in market capitalization, for the most part, mimic the patterns observed when looking at the changes in the number of firms. Exhibit 5 shows that both America and Asia have had very rapid growth in market capitalization over the sample period. The noted difference of course is that the U.S. has shown steady improvement in market capitalization exhibiting exponential growth in recent years, where Asia saw a dramatic increase in the 1995-1997 period with dramatic declines, due to the Asian financial crisis dropping market capitalization back to 1993 levels. Europe has been less volatile, experiencing a slower steadier increase in overall market capitalization than either the U.S. or Asia.

Examining countries of the major regions reveals some interesting trends. For America, the increase in market capitalization is the sole result of the growth in the U.S. markets as Canada, Mexico and Argentina remained flat and there are no other major contributors (Exhibit 6).

Europe experienced the most rapid increase in market capitalization from the UK market with most of the growth occurring between 1996 and the first quarter of 1998. France had grown in the early 1990s but then experienced dramatic declines in market capitalization during the second half of the 1990s as the number of firms shrank. The Netherlands had a slow and stable increase in market capitalization across the sample period (Exhibit 7), while most of the other five European countries had almost insignificant growth. Note that European market capitalizations are only a fraction of the U.S. capitalization.

The market capitalization for the Asia region has been very volatile over time. Japan had strong growth in market capitalization during the early to mid-1980s, which was consistent with their overall economic situation. Hong Kong had dramatic increases in market capitalization from 1984 until midyear 1997, which followed their securities market bubble, then had a major decline bringing current market capitalization back to 1994 levels. Singapore exhibited similar trends to Hong Kong, but on a much smaller scale. Australia has experienced slow but stable market capitalization growth over the sample period, but the market still remains small (Exhibit 8). Asian market capitalizations are similar to European market capitalization and still a fraction of the U.S. market capitalization.

V. IN VESTMENT RETURNS AND VOLATILITY

For the international public real estate markets to evolve and grow rapidly, they need to be attractive to investors by generating strong returns. Return performance and volatility of the three major regions in Exhibit 9 shows that both Europe and America had steady positive returns producing a 500% increase over 20 years with low volatility, while Asia had extremely high returns from the mid-1980s through the mid-1990s but then had substantial losses in the second half of the 1990s bringing investors back to a mid-1980s return position. The U.S. market is also added to the graph to show that U.S. returns were significantly higher in the 1990s from the America region composite.

The average monthly returns arid returns to standard deviations are shown in Exhibits 10 and 11. So, while Asia looked good on a total return basis, on a risk-adjusted return level, both America and Europe performed much better.

Examining the individual countries revel that there are dramatic differences in performance within geographic regions. For example, average monthly returns in the U.S. just over 1%, while the average monthly return in Canada was negative. (Exhibit 12)

In Asia, all of the firms showed positive total returns for the sample period, With Australia producing a similar 500% return to the American and European regions over the 2 decades of the 1980s and 1990s. It was Hong Kong alone that produced the substantially higher returns and volatility that drove the index for the Asia region. (Exhibit 13)

Due to its low volatility Australia produced the best risk adjusted return of the Asian region. (Exhibit 14)

In Europe, Norway and Italy produced the highest level of total returns (Exhibit 15), but Switzerland and France had the highest level of risk adjusted returns (Exhibit 16).

VI. RETURN CORRELATIONS:

Modern portfolio theory states that anytime assets that have less than perfect positive correlation are combined into a portfolio, there are risk reduction benefits. In fact, both the major rationale for real estate investing and international investing stem from their low correlation with other investments in a portfolio allowing for better risk-adjusted returns. Recently, the general international equity markets and debt markets have been moving in relative tandem as indicated by the increasing return correlations. However, real estate in general and international real estate markets in particular, have exhibited relatively low correlations with the other asset classes and also have shown low correlation across the three regions (Exhibit 17).

Examining the correlations within each of the major regions (Exhibit 18) shows that there exist diversification benefits even within any one of the major regions. Return correlations for the period 1982 through 202 are very low with only a few countries having correlations above 0.50. Thus local and not global factors would appear to be driving public real estate company returns.

VII. CONCLUSION

Investing in international real estate is a new challenge that is being considered by more and more investors today. The substantial efforts, risks and costs associated with purchasing direct real estate can be reduced by investing in publicly traded real estate companies around the globe. Public real estate companies have only become a viable option in the last 20 years and their performance (analyzed here) shows positive results. Most countries' public real estate markets have shown relatively steady returns, with the exception of the highly volatile Hong Kong market.

As most public markets grow, a major force in capital flows is the institutional investor entering the market. Institutional investors need liquid markets in order to invest and this is a function of the size of the market. While the reasonable returns and low correlations of most public real estate markets around the world should attract institutional investors, the relatively small size of most markets has made them less attractive. While the U.S. market cap is $170 billion, all other markets are much smaller with France, Hong Kong and Japan averaging around $40 billion being the next closest tier. Smaller and less liquid markets keep many investors away. A few large investors see investments in smaller public markets as similar to making a private investment, due to the low liquidity Thus the public real estate markets around the world still have a long way to go and grow to attract significant institutional capital.

Currency risk is also a major factor in assessing return volatility in the home country currency of the investor. Real estate poses a different type of risk from other stock investments as there can be a large portion of the return coming from annual dividends, while stock investments provide mostly appreciation as the major component of their returns. This annual cash flow from real estate investments means that investors have to develop different currency hedging strategies to manage the annual cash flows. Thus international real estate investments can provide a different challenge as well as a different value to the portfolio.

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[GRAPH OMITTED] Exhibit 10 Average Monthly Returns by Region

Average Monthly Return Return Asia 1.27% Return Europe 0.88% Return America 0.83% Source: GPR Note: Table made from bar graph Exhibit 11 Standard Deviation of Returns by Region

Return/Risk Asia 0.14 America 0.20 Europe 0.20 Source: GPR Table made from bar graph Exhibit 12 Returns for America's Region Countries

Monthly Returns Canada -0.31% U.S. 1.01% Source: GPR Table made from bar graph Exhibit 14 Standard Deviations for Asia Region Countries

Return/Risk Australia 0.23 Hong Kong 0.18 Japan 0.11 Source: GRP Note: Table made from bar graph Exhibit 15 Europe Region Country Returns

Average Monthly Returns France 0.93% Germany 0.66% Italy 1.03% Netherlands 0.62% Norway 1.43% Sweden 0.86% Switzerland 0.95% Source: GPR Note: Table made from bar graph Exhibit 16 Europe Region Country Standard Deviation

Return/Risk France 0.19 Germany 0.11 Italy 0.13 Netherlands 0.16 Norway 0.16 Sweden 0.08 Switzerland 0.23 Source: GPR Note: Table made from bar graph Exhibit 17 Cross Region Return Correlations

Return America Return Asia Return Europe Return America 0.33 0.40 Return Asia 0.33 0.38 Return Europe 0.40 0.38

U.S. Returns Canada Returns U.S. Returns 1 Canada Returns 0.431 1 Exhibit 18 Cross Country (within Region) Return Correlations

France Germany Italy Netherlands Norway Sweden France 0.443 0.442 0.644 0.267 0.182 Germany 0.443 0.323 0.424 0.153 0.019 Italy 0.442 0.323 0.288 0.140 0.047 Netherlands 0.644 0.424 0.288 0.327 0.175 Norway 0.268 0.153 0.140 0.327 0.247 Sweden 0.182 0.019 0.047 0.175 0.247 Switzerland 0.619 0.376 0.192 0.559 0.109 0.096

Switzerland France 0.619 Germany 0.376 Italy 0.193 Netherlands 0.559 Norway 0.109 Sweden 0.096 Switzerland

Australia Return Hong Kong Return Japan Return Australia Return 0.375 0.202 Hong Kong Return 0.375 0.064 Japan Return 0.202 0.064 Singapore Return 0.316 0.611 0.134

Singapore Return Australia Return 0.316 Hong Kong Return 0.611 Japan Return 0.134 Singapore Return

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* Johns Hopkins University & Legg Mason Wood Walker, Inc or grmueller@jhu.edu.

** City University of New York--Baruch College or Randy_Anderson@baruch.cuny.edu.