Foreign Real Estate ETFs Present a Better Risk-Reward Scenario

Mortgage delinquencies on residential real estate are accelerating, not decelerating. Similarly, an estimated $3.5 trillion in commercial loans are in danger of default, with no clear path to refinancing or modification to prevent massive foreclosures.

Does this spell disaster for real estate investment trusts (REITs)? Surprisingly, the answer may be “no.”

Granted, big time real estate trusts do have subprime residential and commercial loan exposure. However, REITs also have the capacity to raise money. And while that may dilute the worth of shares for existing stakeholders, the alternative asset lure of REITs may attract plenty of newcomers.

Bob Pisani at CNBC pointed out that there is a brand new crop of REIT IPOs set to launch this week alone, including Colony Financial (CLNY), Apollo Commercial (ARI), Foursquare Capital (FSQR), and Ladder Capital (LCG). Each plans to take advantage of the extremely distressed residential and commercial real estate world.

This brings me to a point that I have stated in earlier commentary. While existing REIT ETFs may be able to “make it” through diversification across the REIT space as well as relatively low exposure to the bad loans, why bother? Is the 5% or 6% income production really worth the volatility when you have similar yields from international REIT ETFs?

Consider the iShares FTSE/NAREIT Developed World Real Estate excl U.S. Fund (IFGL). This REIT ETF is up 41.4% in 2009 compared to 19.6% for the Vanguard REIT ETF (VNQ). Granted, VNQ may be offering a yield in the 6.5% area where IFGL is closer to 3.75%. Nevertheless, the “world’s real estate excluding the United States“ is vastly superior when one takes into account the state of troubled U.S. loan exposure.

Another possibility for more speculative investors is to seriously consider buying one of the above-mentioned REIT IPOs. Personally, I think it is too risky to get in on the $20 IPO price on any of these offerings. All that is known at this point is the stated intention of these entities to pursue distressed assets. With no idea of what the potential of their acquisitions will be, let alone the true value of those distressed assets, one is gambling on the concept as well as the jockey (management).

For those who are interested, they might do best to wait for financials, including REITs, to experience a bit of a pullback. Then one might consider an entry point with stop-loss protection.

Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.

Comments

[malach hamo...:]

really, now? when you buy a foreign reit you have even fewer benchmarks for control over your investment.

1. they may be investing in countries with a lack of transparency which in real estate can be devastating - imagine how a "legal" nationalization or "taking" can effect the value of your investment when all that's needed to effect such a "taking" is for a locality to connive with the central gov to raise real estate taxes.
2. the currency risk - if you need returns in dollars (to buy corn flakes at the 7-11 or to pay the Mexican girl who comes in at 2:00 pm for your "massage"), you'll find that local returns might be wonderful, but when translated they may provide a rude surprise. Bear in mind that it's a lot easier to effect an inflationary spiral in the real estate markets than in companies involved in international trade.

so, before you pay a 1 percent annual fee for someone to invest in foreign reits which have their own rich management comp structures, figure if that illusory return is really worth the risks, and don't make the 2004-2007 mistakes again.

Sep 22 09:16 AM

[Rokjok777:]

Hah! Transparency? You think investing in the US is "transparent"? Um have you ever heard of SIVs, off-balance sheet investments, mark-to-market suspension? I guess Madoff was transparent, with that famous first-world regulatory oversight environment the US supposedly has. And regarding currency risk, if the US were a third world country, the IMF would be demanding deep structural reforms and draconian measures to shore up the balance sheet, on life support.
So yes, foreign real estate investing carries risks but puh-lease...

Sep 22 06:13 PM

[Panus Skept...:]

With Eastern Europe holding now toxic euro-denominated mortgages, and over 1 million unsold homes in Spain, I'm not at all sure that going overseas does anything for safety. What have you got when you combine a lot of different basket cases?

Sep 23 09:24 AM