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For an investor already diversified among equities, real estate is a solid instrument for overall portfolio diversification. While the American real estate market stagnates to its lowest volume in the last 20 years, investors are looking to put their asset allocation funds elsewhere.

Interestingly enough, real estate in China has been positioned for growth – and despite its already large percentage gains, there still remains additional growth potential. However, for many foreign investors, the choices for traditional real estate purchases are limited by the People’s Republic of China’s government. Having to pay higher land fees, combined with lower property choices for foreigners, it can be monetarily risky for a foreign investor to purchase real estate in China.

However, with that said, a new breed of real estate investment trusts [REITs] has sprung up in China, providing an excellent financial instrument for those looking for proper asset allocation, as well as full diversification internationally. These REITs generate not only income, but also a possibility of capital appreciation over a period of time.

The Development of REITs in China

The GZI REIT (OTC:GZIRF) operating from Hong Kong was the first successful mutual fund to gain a foothold in the property management industry in mainland China. Following the success of GZI, numerous REITs have sprung up, many with operations in Singapore and Hong Kong.

Since capital repatriation is still restrictive in China, Hong Kong REITs provide a mechanism to hold properties in the mainland. The rapidly growing Chinese economy, coupled with the presence of a strong middle class, are indicators that the demand for real estate in China may outstrip supply – giving REIT holders a nice profit in the interim.

Internationally, the Chinese market provides foreign investors with full diversification. Given the potential recession the United States is headed for in 2008, you may want to consider investing your dollars elsewhere. Although many Chinese equities have the economic fanfare of the Beijing 2008 Olympics priced in, REITs still hold potential.

Indeed, with the additional exposure China will obtain among the international community, the real estate market’s demand may be stimulated by this worldwide event. In addition, it is clear that the Chinese government is taking major strides to maximize the PR surrounding this event. For example, they even worked closely with CBS’s highly popular Survivor reality television series to film the most recent season in China.

Major Chinese Real Estate Sectors

While REITs will be great vehicles for investments in residential, commercial office, retail, and industrial development sectors, the Olympics are particularly lucrative for REITs pertaining to hotels and resorts in the short-term. The Beijing Tourism Bureau has estimated that there will be 110 new hotels being developed to accommodate approximately 550,000 guests during the international sports.

The profitability potential for Chinese REITs is tremendous. For example, Starwood Asia Pacific Hotels and Resorts (NYSE:HOT) estimate that approximately 50% of its future profits will be forthcoming from Chinese REITs.

The cities with the greatest potential are certainly Beijing and Shanghai, as the population growth and continuous migration to these economic megacities ensure a strong demand for real estate. For both short-term and long-term investments, REITs can be an excellent way to diversify your portfolio, garnering income and capital appreciation possibilities.

Developing a Chinese REITs strategy

There are two legs of investment strategies for Chinese REITs. For short run profits, the Beijing 2008 Olympics provide an excellent opportunity for investment – but only when it comes to income, as many REITs already have the capital gain priced into the share price.

Of course, for the investor seeking both income and the potential for capital appreciation, the long-term strategy for REITs may be most profitable. The continued population and economic growth of China set the foundation of high demand of real estate.

Investing in Chinese infrastructure

Mainland China’s issues of transparency and changing rule of law pose greater risks for the investor. With that said, investors who have lower risk tolerances may want to consider investing through Hong Kong REITs, which are traditionally more open and subject to international financial transparency and regulations.

Keeping true to the golden rules of investing means that your portfolio should not be more than 15% vested in any particular market. At a time when the U.S. economy is facing a possible recession, an exposure to international REITs can provide a hedge and safety valve against potential slumps in U.S. stocks.