Should pension funds invest in the global real estate market?

Swiss pension funds know the local real estate market very well. For this reason, they have invested heavily in their home market for many years. Nevertheless, the investment opportunities in Switzerland are limited given the restricted size of the market. At the same time, investment potential in foreign real estate has not been fully utilized: When you invest abroad, you diversify your risks and get the opportunity for higher returns in the long term.

One of the decisive developments in the investment world following the global financial crisis is the low level of interest rates. Due to low interest rates assets have a positive valuation.

It is true that real estate prices have risen since the global financial crisis. However, the differences between countries manifest themselves, not in prices, but in the varied development of interest rates. While the U.S. central bank, the Fed, reversed interest rates in December 2015, rates in the Eurozone and Switzerland remain at a low level. Nevertheless, even the U.S. real estate market still offers intact investment opportunities, due to the good situation in the U.S. economy.

An interest rate reversal does not necessarily mean a decline in the real estate market. Despite higher interest rates, a stable economy with falling unemployment and increasing consumption leads to positive performance. In Europe, Germany and France, as well as the Benelux countries and Scandinavia, are among the countries with the strongest economies and offer interesting prospects. Australia is also showing evidence of stable and sustainable growth, rounding off the global investment universe.

A Swiss pension fund can cover around half of the global market with investments in the institutional real estate markets of the U.S., Great Britain and Germany (see figure A). If it takes other real estate markets in Europe and Asia into account, the figure reaches 90 percent. The individual countries have different economic cycles. While rents are increasing in Europe, for example, due to the limited offer, they are growing in the U.S. due to growth in economic centers – and it is this heterogeneity that creates diversification potential.

This heterogeneity can also be statistically determined. The correlation of yields between the different markets is relatively low (see figure B). Over the period between 2002 and 2016, for example, the American real estate market showed a correlation of 0.23 to the Swiss and 0.33 to the German market. The correlation coefficient can assume values of between -1 and +1, with a value of 0 meaning that no connection exists between the variables.

Alongside regional or country-specific diversification, there is also the possibility of spreading risks across different economic sectors. The four most important real estate sectors – offices, retail, housing and logistics – are represented in various economic cycles and show considerable differences in terms of tenant structure as well as capital requirements. They thus make a significant contribution to the diversification of a real estate portfolio.

Although international diversification is highly recommended, the risk class of the specific real estate must always be considered for real estate investments. The sweet spot lies in core real estate in particular, which has the lowest risk. These properties are typically in prime locations in cities and have high-quality tenants. They are highly sought-after, since they are located close to traffic hubs, public institutions and, in the case of logistics plants, close to highways and other transport arteries.

Due to the high demand for core real estate, vacancies are usually of short duration and yields are very stable across the entire economic cycle. Rents are often contractually stipulated for many years. Furthermore, the debt capital ratio is usually low. For foreign core properties, investors pursue a long-term and robust investment strategy.

When it comes to transparency, the U.S., Great Britain, Australia and France are role models for other real estate markets worldwide. Statutory framework conditions, high standards with regard to data availability and quality, and frequent performance measurements with high demands ensure this high transparency (see figure C).

Thanks to their high investment volumes, institutional investors have optimum access to investment opportunities across all markets worldwide. The challenge is rather choosing the right one from among the many investments; so that expert knowledge, experience and most importantly an excellent local network are indispensable when it comes to managing properties efficiently, analyzing and structuring transactions correctly and ultimately executing them successfully.

(Figure A)

(Figure B)

(Figure C)