Challenging the conventional wisdom


“We’re not doing this analysis just to sell property,” states Hans Vrensen, global head of research at property services firm DTZ. He is responding to a legitimate ‘devil’s advocate’ suggestion that the firm’s incoming First Steps in Global Investing portfolio modelling initiative is a ploy to drum up business in markets where it wants to be more active.

The initiative, aimed at Asian institutional investors not yet invested in overseas real estate, has such investors making their overseas property foray in secondary markets like Milan and Beijing, sidestepping traditionally more popular markets like London or New York.

“In the first instance, we’re doing this to challenge conventional wisdom,” says Vrensen. “We believe that investors should consider all relevant market options carefully based on the most up-to-date pricing.” The intent of the Dutchman and his colleagues – global head of forecasting Fergus Hicks and senior analyst Charlie Browne, the latter of whom leads the initiative – is more to provoke greater consideration for global markets among Asian institutions than they currently believe is happening.

Go your own way 

“The pattern has emerged over the past three or four years: Asian institutional investors buy in London and New York first, then maybe Paris, Frankfurt and Los Angeles,” Vrensen says. “These are typical first steps.”

Asian investors such as the National Pension Service of Korea and China Investment Corporation have been successful in their early exploits, but Vrensen points out that prices in these gateway markets have adjusted rapidly since then. “That is why the timing of our analysis is good,” he says. “The second or third wave of Korean institutions, for example, really should ask themselves: Should I still follow the leader into a re-priced market?” DTZ’s answer to that question is that Korean institutions yet to invest overseas should not.

It is no coincidence that the hypothetical Korean investor, with only domestic property on its books, makes for DTZ’s pilot case study. Since 2009, Korean institutions have invested some $10.8 billion outside of their domestic market, according to the firm’s numbers. In the past three years, London, New York and Chicago have seen $3.1 billion of that total. Of that, 62 percent went to London. Meanwhile, prime offices in the English capital, a favored asset type of Korean institutions, have seen yields fall from 5.25 percent since 2009 and from 4.5 percent since 2011 to 4 percent today.

DTZ analysis suggests that investments made in Milan and Beijing would better supplement a Seoul-dominated port-folio. That conclusion, based on the firm’s portfolio modelling work, is predicated on three key components: a market’s risk, its historical returns and how those returns correlate with other markets. Recommendations consider only a pool of 21 markets that DTZ regards as being most liquid: seven each for Europe, North America and Asia.

Browne, who led the initiative as part of his chartered financial analyst program before Vrensen asked him to expand it for the wider DTZ research team to develop, says it primarily should recount “combinations of markets and work out which is best.” While the Korean investor served as a prototype, the firm already has worked out combinations for other investors and more detailed analysis will be offered to those in due course.

 No Martians here  

DTZ assumes initial, incremental allocations of 10 percent and that institutions invariably will be starting with an existing property portfolio.  The characteristics of that portfolio are important for determining which international markets warrant investment. 

“People aren’t coming from outer space with $10 billion to invest asking, ‘Where in the world should I go?’” Vrensen quips. “They start from a place and more than likely have built up a portfolio of assets in that country first before looking outside. Typically, they already are diversified internationally in other asset classes, like stocks and bonds.”

Hicks places emphasis on the correlation component of DTZ’s analysis. “If you look historically at Seoul compared to Beijing, for instance, you’ll note that they have had a low correlation,” he explains. “When returns in Beijing have been strong, they have been weak in Seoul. When combined, however, the blended return smoothes out the combined portfolio’s return, making it less risky.”

Hicks admits there still are diversification benefits for the Seoul institution that acquires property even in a yield-
compressed London market. However, using DTZ’s modelling and thus pursuing markets uncorrelated with the South Korean capital city, he says, should enable it to achieve greater diversification benefits elsewhere and therefore a more stable return from its overseas property.

“Correlation drives the results much more than we had expected,” Vrensen says. “Picking markets demonstrating a negative correlation to Seoul should give you lower risk. That’s why Beijing shows up. It didn’t seem logical at first because it is so close geographically, but its returns are less correlated than London or New York.”

Vrensen says First Steps is quantitatively-driven and that geopolitical factors are not considered, although Chinese and Japanese institutions proved an exception to the rule. According to the modelling, Chinese investors would be better off investing in Tokyo and Japanese investors were better off investing in Beijing. However, given recent political tensions between the two countries, these findings were considered impractical. Beyond that exception, he notes that geopolitical factors are indirectly implied given they would have impacted each market’s historical return data.

As a result, DTZ reckons Chinese institutions should prioritize Milan and Seoul. More surprising, though, it believes Japanese institutions should favor Dallas and Milan.

“DTZ doesn’t have a nationwide investment agency business in the US yet. If you want evidence of our independence, there it is,” says Vrensen in a further response to PERE’s earlier question on impartiality. Meanwhile, Singaporean institutions are best off investing in Beijing and Seoul, as are Australian investors.

Ready or not  

Now comes the hard part: encouraging the very investors this initiative is intended to influence to respond proactively. “As we have not launched the report yet, we look forward to the feedback,” says Vrensen.

The initiative is in its infancy for sure, but Vrensen fears many new Asian investors are not yet as open to research messages as other international investors. Indeed, many prefer to adopt a safety-in-numbers approach when investing in real estate overseas. “This is a sophisticated message constructed under the limitations of the real world,” he adds.

Despite a certain resignation regarding today’s attitude from Asian institutions, Vrensen is optimistic it will change. Further, he expects Japanese and Australian investors to be among the first to engage. Chinese institutions – many of which only recently have received regulatory clearance to invest in property at all, never mind property overseas – might take longer to be receptive. 

Conversations with certain institutional investors from each country coincide with Vrensen’s forecast. Shinji Kawano, head of global investment at Tokio Marine Property Investment Management, the real estate investment management arm of Japanese insurance giant Tokio Marine, tells PERE: “Maybe Japanese investors can benefit most by investing into Dallas or Milan rather than London or New York because Japanese real estate is closely related to global trade, as are London or New York. They are less correlated and would enable Japanese investors to diversify their real estate portfolio.”

Still, Kawano submits: “I think real estate performance really depends on individual assets or managers. Even though Dallas and Milan are good markets under desktop simulation, it is not assured we can access the best assets or reach the best managers in those markets. On the other hand, there will be more good options in terms of both in London or New York.”

Kawano concludes: “Therefore, I agree that Dallas or Milan can be the best investment destinations theoretically.  However, if we consider it realistically, London or New York still may be the non-negotiable candidate.” Last year, Tokio Marine, with direction from institutional advisory firm Townsend Group, launched a fund of funds to invest in funds across global core markets, starting with investments in the UK and the US.

Hing Yin Lee, senior executive director at Ping An Trust, one of the investment entities of Chinese insurance giant Ping An, does not see Chinese investors changing tack anytime soon. Admitting risk-adjusted returns in “other markets” are compelling, he says: “I would say that Chinese insurance companies still are super-conservative and initially would focus on the more familiar markets of New York and London.”

True to its word, Ping An last year made its overseas property debut, buying the Lloyd’s of London building. At a 6 percent initial yield, however, the investment is well above the 4.5 percent average yield achieved by prime City of London assets last year.

Vrensen, however, contests the idea that investing in prime property in London and New York necessarily equates to operating conservatively. “Is it really risk-averse to buy at historically low initial yields in prime gateway markets?’” he asks.

Nevertheless, it is such mindsets that the DTZ analysis is intended to evolve. As such, the firm’s research head welcomes dialogues with those who would contest the premise. “We think this is a cutting edge idea,” he says. “Some people simply might not be ready for it yet.”