International REITs: China Vs. World?

July 01, 2009

Foreign real estate ETFs are having a banner year. But in a crowded field, funds leaning the most heavily toward Asia are ahead of the pack.


Just like most other sectors, U.S. real estate investment trusts are taking advantage of a broad rally in stocks. In the past three months, for example, the broad-based Vanguard REIT ETF (NYSEArca: VNQ) has soared more than 28% as investors look for a bottom in the credit meltdown.

Still, VNQ is down more than 13% in 2009. In the past 12 months, it has fallen by more than 40%.

A stark contrast is the rapidly evolving international REIT exchange-traded funds segment. At the end of 2006, the first global fund of its kind launched. The SPDR Dow Jones International Real Estate ETF (NYSEArca: RWX) now has at least 10 global-themed rivals. Some are widely diversified, while others are very regional or country specific in nature. (See table on last page.)

As a group, they’ve held up through the mortgage meltdown and worldwide recession much better than domestic REITs. RWX has actually gained a bit more than VNQ in the rally that began in March. And it’s up by double digits so far this year.

Towering over the field, though, is the Claymore/AlphaShares China Real Estate ETF (NYSE: TAO). Since the rally’s start it has gained more than 60%. This year, it’s up more than 63%. In large part, how much exposure more diversified regional and global REIT ETFs have to China and closely related markets in Asia is driving short-term results.

Diverging World Markets

Most key world markets have succumbed to the same basic set of problems in the past two years, some more so than others. But the recent rally has had a decoupling effect, notes Chip McKinley, a portfolio manager for Cohen & Steers Capital Management’s global real estate strategies, which runs about $5 billion in U.S. assets.

“Correlations were tight when all markets were falling. But we’re starting to see a real divergence in the past several months as economies have rebounded,” he said.

Asia is far and away the leading performer this year. So far in 2009, the widely followed FTSE EPRA/NAREIT Global Real Estate Index of developed and emerging markets has jumped more than 35% since mid-March. Much of that has come from an even bigger jump by the Hong Kong portions of the benchmark. Singapore’s real estate market has been the next-best performer of late.

“There has been a huge dislocation between Asia and the U.S. as well as Europe this year in commercial real estate investments,” said McKinley. “The huge stimulus efforts in China alone have resulted in far better than expected activity in real estate developers. And it’s spreading across Asia.”

Asian countries have embraced using public funding to support local development, he added. “It stands as a very stark contrast to what’s happening in the U.S. and developed Europe. In China, they’re in a really robust and V-shaped recovery,” McKinley said.

That’s bringing more capital investment from overseas, he added. “We’re seeing a tremendous amount of capital formation taking place right now in China and much of the rest of Asia,” said McKinley. “But this improvement in commercial real estate activity is starting in China and likely will be the primary beneficiary, although we’re seeing some momentum spreading to other countries as well in the region.”

That’s evident by the run of TAO. It’s also apparent by the under-performance of Europe and Japan. Of global REIT ETFs investing at least partially outside the U.S., the iShares FTSE EPRA/NAREIT Developed Europe Index Fund (Nasdaq: IFEU) has been the biggest laggard. It has risen slightly more than 22% since the rally began and barely has remained in the black for the whole year.

A big part of that drag in 2009 has come from the U.K. and its oversized exposure to financial sectors, says Dina Ting, a senior iShares portfolio manager who oversees BGI’s international real estate funds.

“Office and retail REITs in the U.K. have been significantly weakened by the credit crunch,” she said. “And even in the parts of Asia most affected by the downturn, property values aren’t as expensive relative to the U.K. and other heavily hit parts of Europe.”

As a result, Asian markets had less room to fall in terms of finding a floor to real estate prices. By the same token, they could provide the most room for growth as China aggressively pumps public funds into commercial development, says Ting.



A New World Order In REITs

Another dynamic Ting points to is the fact that the development of REITs has enabled a whole new class of non-U.S. investors to get involved in the market. “Before, you actually had to buy properties. By having REIT stocks available, people who can’t invest directly in properties can now invest in the asset class. It’s a new phenomenon for international investors outside the U.S.,” said Ting.

The structure of REITs is relatively new for the rest of the world, she adds. “Many of these international real estate companies in global indexes aren’t REITs as we’d strictly define them in the U.S.,” said Ting. “But they behave like REITs since they still own buildings, in general, and earn income from rentals, for example. So for all practical purposes, they look and act like REITs.”

Cohen & Steers’ McKinley agrees. “While laws are different on an international basis, the basis of the REIT structure has been widely adopted across the world in the past six years,” he said. “There is now a common set of rules allowing for the free flow of real estate capital around the globe. It has really opened up the property markets to investors who previously had great difficulty in accessing real estate markets.”

But real estate companies aren’t out of the woods. With credit still tight, development projects around the world are crimped. And after a five-year run that lasted through 2007, REIT managers say they’re coming out of the latest recession mindful of boom-and-bust cycles in their industry.

That has translated into relatively conservative strategies in running their businesses, says Ting.

“In the past few months, real estate firms have been more successful at raising money for new acquisitions and projects. But they aren’t necessarily expanding right now. With credit markets still tight, they’ve been more concerned with controlling costs and reducing the size of debt on their books,” she said.

Surveying The Field

The most widely followed investable global real estate index is the FTSE series, according to McKinley. “It’s the closest to a comprehensive global pure real estate index,” he said. “It doesn’t include construction companies, for example. This is an index based on tracking companies that own institutional-grade commercial real estate.”

The First Trust FTSE EPRA/NAREIT Global Developed Markets Real Estate ETF (NYSEArca: FFR) follows the broad benchmark’s no-emerging markets portions. Although a bit of China (1.03%) has made it into the portfolio, FFR has a third of its assets in the U.S. Hong Kong (18%) and Japan (14.18%) are its other dominant countries.

For investors who want a one-stop global ETF, the First Trust fund has several competitors. The iShares FTSE EPRA/NAREIT Developed Real Estate ex-U.S. Index Fund (Nasdaq: IFGL) tracks another subset of the EPRA/NAREIT index. It also focuses on developed foreign markets, but largely excludes the U.S. As a result, its top countries are: Japan (22.4%); Hong Kong (19.5%) and Australia (13.3%).

Barclays Global Investors also offers a series of REIT funds that splice the FTSE index into different regions—developed Asia (IFAS), developed Europe (IFEU) and North America (IFNA).



There’s also an iShares fund (WPS) tracking a Standard & Poor’s REIT benchmark of developed markets outside of the U.S.

That makes a total of five international REIT ETFs totaling more than $400 million in total assets from the iShares family.

Another noteworthy competitor is the WisdomTree International Real Estate ETF (NYSEArca: DRW). The fund follows its own specially developed index that weights real estate companies outside of the U.S. and Canada based on cash dividend streams. Currently, Hong Kong is dominating its portfolio at around 27.65% of total assets. Japan, Australia and France follow.

Also, besides RWX, State Street Global Advisors launched the SPDR Dow Jones Global Real Estate ETF (NYSEArca: RWO) last year. It’s one of the category’s laggards this year—and for good reason. Nearly 55% of the fund’s assets are invested in the U.S. and Japan. Better performers such as Hong Kong, Singapore and China are bit performers in this portfolio.


ETF Symbol Top Countries (%) Exp. Ratio (%) Stocks* YTD Return (%)**
Claymore China TAO China 0.65 40 63.88
iShares Developed Asia IFAS Japan (32.7), Hong Kong (28.6), Australia (19.5), Singapore (10.1) 0.48 65 25.97
iShares FTSE Developed ex-U.S. IFGL Japan (22.4), Hong Kong, (19.5) Australia (13.3), U.K. (8.7) 0.48 152 20.14
WisdomTree Int’l DRW Hong Kong (27.7), Japan (16.8), Australia (16.4), France (13.3) 0.58 218 16.35
iShares S&P Developed ex-U.S. WPS Japan (26.6), Hong Kong (23.3), Australia (13.9), Singapore (7.6) 0.48 228 15.61
SPDR DJ International RWX Japan (24.1), Australia (15.7), U.K. (12.6), Hong Kong (10.7) 0.59 135 11.47
First Trust FTSE Developed Global FFR U.S. (33.9), Hong Kong (18), Japan (14.2), Australia (8.8) 0.60 265 3.66
iShares FTSE Developed Europe IFEU U.K. (32.3), France (30.8), Netherlands (11.5), Switzerland (6.0) 0.48 79 0.05
SPDR DJ Global RWO U.S. (39.6), Japan (14.3), Australia (9.4), U.K. (7.4) 0.50 215 -1.94
iShares FTSE North America IFNA U.S. (90.1), Canada (9.1) 0.48 115 -11.96

Sources: Companies, Morningstar *As of March 31, 2009 **As of June 30, 2009


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