International Real Estate Volatility: A Tactical Investment Strategy

By Mueller, Glenn R.; Boney, Vaneesha et al. | Journal of Real Estate Portfolio Management, October-December 2008 | Go to article overview

International Real Estate Volatility: A Tactical Investment Strategy


Mueller, Glenn R., Boney, Vaneesha, Mueller, Andrew G., Journal of Real Estate Portfolio Management


Executive Summary.

In the last few years public real estate vehicles and the REIT concept have expanded into many countries including the United Kingdom in January 2007 and Germany in March 2007. With more investment opportunities, many new international real estate investment funds have sprung up around the world. Therefore new investment strategies to help international real estate investors are needed. Much new research on international real estate returns and country correlations have been performed, but few if any new investment strategies have been developed. This paper looks at a long-term real estate return series collected by Global Property Research (GPR) and finds that the long-term correlations between the three continental regions-North America, Asia, and Europe-are relatively low, thus providing valuable return and diversification benefits. An active allocation strategy is developed for high, medium, and low volatility periods in each region. The findings indicate that investors could have received excess returns by adjusting their regional portfolio allocation weights during different volatility periods in each region.

Investors are increasingly including real estate equities in their investment portfolio. In the United States, Real Estate Investment Trusts (REITs) are a major means of inclusion. With a market capitalization of more than $400 billion,1 publicly traded real estate property companies in the U.S. trade on all major stock exchanges and offer investors the opportunity to diversify their portfolios with securitized real estate assets, and historically low correlations with the general stock market. Previous literature has shown that most investors stand to earn higher risk-adjusted returns by adding real estate to their portfolio than by investing solely in common stocks (see Mueller, Pauley and Morrell, 1994; and Grauer and Hakansson, 1995).

The real estate securities have had significant global growth as well (Exhibit 1). This global expansion begs the question of whether the growth and volatility of global real estate markets present challenges or opportunities to international real estate investors. This question is of interest given that many investment funds are taking a global approach with respect to their real estate portfolios. This notion is substantiated by Conover, Friday, and Sirmans (2002), who find that foreign real estate tends to have a lower correlation to U.S. stocks than either U.S. real estate securities or foreign stocks. Using the global real estate investment focus, this analysis develops a tactical allocation strategy by examining monthly return and volatility trends over a 22-year time period from 1983 to 2005 to determine if a regional weighting change, given different levels of historic volatility, can outperform an optimal long-term allocation strategy. Specifically, the returns and volatilities of many countries are grouped by continental region: Europe, Asia, and North America. Optimized riskreturn portfolios are then constructed (based upon Markowitz efficient frontiers) by changing regional allocations when volatilities change, according to three defined volatility levels: low, medium and high. The results show that investors can increase their returns significantly by tactically adjusting their regional allocations during the different volatility periods. The resulting allocation strategy should prove most useful for portfolio managers who have a global real estate investment mandate. Optimal portfolio results are presented for American, Asian, and European investors.

Literature Review

The international real estate equities market has realized significant growth over the past decade. Accordingly, the literature is now exploring issues involving these public markets. Volatility, correlation in returns across various international markets, and the potential diversification benefits of including international real estate in a domestic portfolio are the topic of many studies.

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