Investment In Real Estate: The USA Or International?

| About: Vanguard Global (VNQI)

Summary

Real estate investments provide excellent opportunities to diversify portfolios.

Investors can choose between the USA and international REITs, which have different portfolio allocations, risks, and returns.

Investments in US real estate market represent higher returns and lower risk compared to the international real estate market.

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Investment in real estate investment trusts can be a good way to diversify portfolios and attract investors.

  • Real estate is an excellent way to diversify equities in portfolios because of the small correlation.
  • The dividend yield is significantly higher for REITs relative to equities.
  • Real estate is inversely correlated with the bond markets: While bond prices fall, REITs increase in price due to stronger economies and increased rent profitability.
  • Superior liquidity. Shares trade on the exchanges and are easily transformed into cash.
  • With minimum investments in REITs, investors can achieve access to the property that most investors can purchase, such as shopping malls, offices, hotels, and storage spaces.
  • Taxes. REITs are taxed only at the individual shareholder level, while equity is taxed on both the corporate and individual levels.

The disadvantages of investing in REITs:

  • REITs require a minimum payout of 90% of the profit, which limits shareholders' ability to generate future growth through reinvestment.

What is the performance of REITs relative to equity?

To compare, I will use Dow Jones Equity Reit Total Return Index (Bloomberg Ticker: REIT) and MSCI ACWI Index (Bloomberg Ticker: MXWD). For the past five years, Dow Jones Equity Reit Total Return Index outperformed the MSCI ACWI Index by 3.91%.

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Source: Bloomberg Terminal

For further analysis, I will compare the Vanguard Global Ex-US Real Estate ETF (NASDAQ:VNQI) for international real estate investment and iShares U.S. Real Estate ETF (NYSEARCA:IYR) for domestic real estate investment. I will compare both ETFs with SPDR 500 ETF Trust (NYSEARCA:SPY) as an opportunity investment for the U.S. investor.

The American real estate market

For the last year, the iShares U.S. Real Estate ETF slightly underperformed the Dow Jones US REIT Total Return Index (benchmark) and the SPDR 500 ETF Trust.

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Source: Bloomberg Terminal

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Source: Bloomberg Terminal

  • While the dividend yield is significantly higher for the iShares U.S. Real Estate ETF, the earnings yield is higher for the SPDR 500 ETF Trust.
  • The iShares U.S. Real Estate ETF is overpriced compared to the SPDR 500 ETF Trust based on the P/E and P/S ratios.
  • Still, the iShares U.S. Real Estate ETF is underpriced compared to the SPDR 500 ETF Trust based on the P/B ratio.
  • The iShares U.S. Real Estate ETF is less risky than SPY based on the beta.
  • ROE and ROA are lower for the iShares U.S. Real Estate ETF compared the SPDR 500 ETF Trust.

The international real estate market.

For the past year, the Vanguard Global Ex-US Real Estate ETF significantly underperformed the SPDR 500 ETF Trust and was relatively close to the S&P Global ex-US Property Net Total Return Index (benchmark).

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Source: Bloomberg Terminal

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Source: Bloomberg Terminal

  • The earnings and dividend yield are considerably higher for the Vanguard Global Ex-US Real Estate ETF.
  • The Vanguard Global Ex-US Real Estate ETF is undervalued compared to the SPDR 500 ETF Trust, based on the P/E and P/B ratios.
  • Still, the Vanguard Global Ex-US Real Estate ETF is overvalued compared to the SPDR 500 ETF Trust, based on the P/S ratios.
  • The Vanguard Global Ex-US Real Estate ETF is less risky than the SPDR 500 ETF Trust based on the beta.
  • While ROA is higher for the Vanguard Global Ex-US Real Estate ETF, ROE is greater for the SPDR 500 ETF Trust.

What contributed to the poor performance of Vanguard Global Ex-US Real Estate ETF?

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Source: Bloomberg Terminal

  • A significant portion of the portfolio (over 70%) is invested in developed markets, while the rest is invested in emerging markets.
  • Japan had the largest concentration in the portfolio and generated the highest returns. Japan is hosting the 2020 Olympic games and expects to spend $3.8 billion on building sports facilities and hotels to accommodate 20 million tourists. In light of the increased interest from Asian investors, negative interest rates that allow companies to negotiate favorable terms, and the upcoming Olympic games, Japan's real estate market can be viewed as a safe long-term investment.
  • While the United Kingdom consists of 7.64% of the ETFs holdings, it is the largest underperformer out of all countries. The underperformance is based on the recent decision to leave the European Union. With a lower macroeconomic outlook, the prices on real estate may lower in the next few years. In light of the expected decline in prices and weaker pound sterling, the UK is expected to continue to underperform for the next biennium.
  • China and Hong Kong consist of 19.4% of the ETFs. Chinese real estate underperformed by 0.44%. Most analysts believe that the market is overheated and the real estate bubble will burst in 2018. There are signs that the real estate bubble is transferring from Mainland China to Hong Kong.
  • Canada and Australia consist of 13.04% of the portfolio. Real estate prices had soared by 71% since 2003, which is higher than 47% in the USA before the biggest real estate bubble that led to the recession of 2007-2009.
  • Based on the UBS Real Estate Bubble Index, the following cities have the highest probability of the real estate bubble: Vancouver (Canada), London (U.K.), Stockholm (Sweden), Munich (Germany) and Hong Kong (China).

Currency risk

Depreciating foreign currency translates into a decrease in the value of shareholders. Based on the FX forecast, the UK has significant exposure to currency risk:

  • GBP is forecasted to depreciate to 1.54 from 1.25 in the next year.
  • CAD and CNY are expected to depreciate slightly. AUD is expected to remain stable.
  • JPY is expected to appreciate to 0.086 from 0.0097, which translates into higher shareholder value.

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Source: Bloomberg Terminal

Is there any difference in the type of REIT allocation?

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Source: Bloomberg Terminal

Vanguard Global Ex-US Real Estate ETF

  • The firm side of VNQI is significant allocation into diversified REITs, which decreases exposure to a single factor.
  • The weak part of VNQI is 29.72% allocation into retail, office, and industrial ETFs. The profitability of the mentioned REITs depends on job creation.

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Source: Bloomberg Terminal

  • Unemployment is expected to decrease in France, Australia, Canada, Germany, and Japan, which consists of more than 70%. Therefore, retail, office, and industrial REITs are expected to be stable.

iShares U.S. Real Estate ETF

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Source: Bloomberg Terminal

  • In light of the lowering unemployment rate, REITs are expected to continue to perform well for the next two years.

Which markets are projected to perform better going forward?

Investors who want exposure to real estate should choose the iShares U.S. Real Estate ETF (US market) over the Vanguard Global Ex-US Real Estate ETF (international market) for the following reasons:

  1. For the last year, the iShares U.S. Real Estate ETF performed better and was in line with the SPDR 500 ETF Trust.
  2. The International real estate has a significantly higher risk because of the anticipated real estate bubbles in the UK, Canada, China, and Australia.
  3. Investment in U.S. markets eliminates currency risk, which is expected to decrease the value of the Vanguard Global Ex-US Real Estate ETF shareholders.
  4. US REITs specializing in a single industry are projected to continue good performance based on the increased employment forecasts.
  5. Markets expect an increase in interest rates this December, which is expected to improve the performance of U.S. REITs even more.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.