Property prices in Asian countries have been rising at a staggering pace in the past few years due to the strength of their economies. Even during the global credit crisis last year prices did not decrease much, if at all, in most Asian countries.

In recent months, in addition to the spectacular run up in equity markets, Asian real estate markets have also heated up. In most countries this rise is not warranted based on fundamentals. While it's true that traditionally most Asians bought residential real estate as a place to live for life as opposed to making a killing via flipping, in recent years that attitude has been changing. Due to the availability of cheap credit, more Asians have become real estate speculators.

With a roller coaster six months behind us that saw no shortage of interesting twists and turns and unsuspected headlines, we’ve finally reached the midway point of 2009.

Ahead of us is the highly anticipated “second half of 2009,” which for months we’ve heard will hold returns to growth, a recovering economy, and enough green shoots feed a revolution (possibly the one taking shape in the streets of Iran?).

As the first half of 2009 draws to a close, it seems that we’re finally starting to see things return to some semblance of normality. Equity markets have rallied sharply since bottoming out in March. Volatility is back within its historical range after hitting record highs over the past year. And politicians in Washington have been able to slowly turn their attention from the economy to other important disagreements, such as how to proceed in Iran, how to reform healthcare, and what to do about America’s dependence on foreign oil.

But despite all these green shoots in the economy, U.S. real estate ETFs remains stuck in a rut, lagging far behind global rivals who have enjoyed tremendous rallies in recent months.

By Brandon Clay

The Citi Private Bank report commissioned from Knight Frank provides a fascinating snap-shot of global property markets, and relative performance in the fourth quarter of 2008.

The biggest falls in residential property prices were in Hong Kong (-26.8%), Home Counties (-19.4%, the region surrounding London), London (-16.9%) and Dubai (-19.1%).

Great article on TheStreet.com by Roger Nusbaum last week highlighting how simple it is to create an 'El-Erian' styled portfolio using simply exchange-traded funds (ETFs). If you're unfamiliar with Mohamed El-Erian, he is the CEO of the largest bond manager in the world, PIMCO. And, he's a pretty smart guy. You should definitely check out El-Erian's book When Markets Collide. It discusses the current fundamental changes going on in the global economy and financial markets/systems. This book also recently won the Business Book of the Year for 2008. In the book, he touches on a new type of portfolio and this is what Roger has sought to re-create in simple form.

The breakdown of the portfolio is as such:

The U.S. commercial real estate market in June hit its lowest annual price appreciation since May 2001, according to the Standard & Poor's/GRA Commercial Real Estate Indices. The national composite is comprised of 10 underlying indexes, which cover both geographic, and real estate sectors, and tracks price appreciation month-by-month, and year-over-year.

At the end of June, the composite index had an annual price appreciation of 1.5%. This is a far cry from the cycle's peak of 14.7% in August 2006, and the lowest growth rate since the 1.7% rate in May 2001. In May 2008, the index had been up 3.6%. The composite index was flat for the month of June.

Boeing, Durable Goods Ground Transportation, Aerospace ETFs

A double whammy of bad news took the aerospace and defense ETF lower yesterday.

First, orders for durable goods (those items meant to last three years or more) were stagnant last month. Metals, machinery and autos were among the items that felt slowing demand in May, reports Bob Willis for Bloomberg.

After Claymore’s February liquidation, investors have been turning a critical eye to the viability of lightly traded ETFs.  

The PowerShares FTSE RAFI International Real Estate Portfolio (PRY) was launched on December 28, 2007, as PowerShares’ first international real estate ETF. PRY, however, was not the first fund to chart these waters. WisdomTree’s International Real Estate (DRW), launched in June of 2007, offers similar exposure with a different methodology. While DRW has traded an average of 34,700 shares per day in the past three months, PRY has averaged less than 10% of that, trading 1,600 per day over the same period. The fund currently ranks No. 60 in the PowerShares Momentum Tracker newsletter. 

The four big asset classes are stocks, bonds, cash and real estate. Direct ownership of real estate is the pure form of the asset class. To achieve diversification within the financial capability of most investors, securitization of a direct real estate portfolio (REITs) is a second best solution.

REIT vs REAL ESTATE FUNDS:

A reader left a question asking how much to allocate to REITs in a portfolio. He noted David Swensen's 20% suggestion and wondered if that number is too high. The reader also asked about foreign REIT exposure.

To me this is like asking how much to put in commodities. For either question, there is no shortage of smart people and well-written white papers suggesting big numbers to these asset classes.

He is 35 has $30,000 to invest and plans to put aside around $500 a month in this portfolio for the next 5 years at least.

Last week, PowerShares added to its lineup of strategy and fundamental ETFs with the rollout of two more funds based on the Dorsey, Wright & Associates Technical Leaders indexes and an international real estate ETF tracking a FTSE RAFI index.

The other day I read a paper on the October issue of Financial Planning magazine. The article, Think Globally by Bruce Eidelson, discussed the appeals of global REIT (real estate investment trust) to investors who seek diversifications and steady income streams, when the US real estate market struggles. One of the reasons to go global can be illustrated by the following table, which shows the correlations of real estate markets between several developed countries, including US, Canada, UK, Netherlands, France, Japan, and Australia.

As we know, a well diversified portfolio can lower the risk because with different asset classes that don’t move in the same direction at the same time, the chance of either sharp rise or steep decline of the portfolio can be reduced. How well two asset classes (or securities) move in relation to each other is measured statistically by the correlation between the two. A correlation of 1 means the two asset classes move, either up or down, at the same time. To minimize the risk, we want asset classes in a portfolio to have weak correlations (it would be perfect if two asset classes have 0 correction, but that’s unlikely in real life).

Editor's Note: This article is Part IV in a four-part series (see parts I, II and III). Since the original research was conducted on September 28, 2007, updated comments as of October 17, 2007 are included in this writing.

Expanding the Analysis to Other Asset Classes

In Part III of this four-part series, I concluded the periods following the first Fed rate cut in July 1995, September 1998, and January of 2001 were most similar to today's economic landscape. We can use the information from Part III as one of many factors when determining our asset allocation for the coming year. The next logical step is to explore how different asset classes performed relative to each other in each of the three respective historical periods (1995-1996, 1998-1999, 2001-2002). I used the historical performance of each asset class to construct asset allocations which would have been prudent for each particular period. The resulting three asset allocations can then be combined into one allocation using the similarity weights found in Part III, Table 3, column 2. If there is a 16.54% probability the next year may look like 2001-2002, it makes sense to consider weighting 16.54% of your assets to an asset allocation which performed well under those economic conditions. The same is true for the other two historical periods. I have made these allocation calculations down to the last penny, but the detail is not necessary to convey the results. The specific results are not as important as the relative results, such as gold stocks performed better than long-maturity U.S. Treasury bonds in the year following the first Fed rate cut. Graph 1 illustrates the similarity-weighed historical path of each asset class one year after the first rate cut by combining weighted daily historical data from each of the three periods.

Investors in the U.S. now have a wider variety of funds to choose from to gain exposure to non-U.S. commercial property (real estate). In the beginning, there were actively managed funds from Cohen and Steers [IRFAX] and Fidelity [FIREX]. Then came the first index product, State Street’s SPDR Dow Jones International Real Estate ETF (RWX), which rapidly accumulated over $1 billion in assets. Now there are two more index offerings, one from Barclays Global Investors -- the iShares S&P World ex U.S. Property Fund (WPS), with an expense ratio of 0.48% compared to the SPDR’s 0.60%, -- and the Wisdom Tree International Real Estate Fund (DRW) with an expense ratio of 0.58%. While the State Street and BGI products use market capitalization weighting, the Wisdom Tree fund, in keeping with the firm’s fundamental indexing approach, weights its holdings by their respective dividend yields.

Earlier this year, iShares launched three new ETF products in the United States based on the industrial/office (FIO), residential (REZ), and retail (RTL) subsegments of the broad FTSE NAREIT index. Presumably, part of the logic for these new products was to make it easier for investors to implement sector rotation strategies within the domestic property asset class, on the assumption that the returns on different sectors would have low correlation with each other, and would vary differently over the economic cycle. So far, a quick look at these three products’ price history will show you that this theory hasn’t quite panned out, with macro factors that affect the broad real estate asset class seeming to overwhelm any segment factors that are at work.

Quote of the Day- "From the House's Mouth"

“All of the old-timers knew that subprime mortgages were what we called neutron loans — they killed the people and left the houses. The deals made in 2005 and 2006 were going to run into trouble because the credit pendulum at the time was stuck at easy."- Louis S. Barnes, a partner at the Boulder West mortgage banking firm in Colorado, on the fact that there were signs of trouble in the subprime market long before the current crisis. Few were looking for them. (NY Times, Aug. 19th)

BGI decided to fill one of the rare holes in its broad exchange-traded fund [ETF] line-up last week with the launch of an international real estate ETF. The iShares S&P World Ex-US Property Index Fund (WPS) began trading on the NYSE Arca on Friday. The fund tracks the S&P/Citigroup BMI World ex-US Property Index. BGI is positioning the new ETF as a complement to its group of seven U.S. REIT and real estate ETFs.

"The iShares S&P World ex.-U.S. Property Index Fund meets several important needs of investors - accessing a market with a cost effective, tradable investment vehicle and diversification beyond what U.S. real estate can provide," said Noel Archard, head of U.S. iShares Product Development. He added that many U.S. investors find it difficult to invest in the international real estate market because of issues like high costs, poor access and lack of liquidity.

Some analysts and investors believe that the heavy selling was too extreme and that some REITs - particularly those in the office and retail sectors - could stage a comeback. Indeed, just as the residential housing slump has produced some steals for home buyers, the REIT sell-off may similarly yield some good deals for stock-market investors. [Emphasis added.]

Similar articles were written in 2000 and 2001 about Cisco (CSCO), as the networking giant fell from $80 to $55-$60. The fawning press, and clueless analysts wrote that the all-mighty Cisco was also a "bargain" because it had fallen 25%.

Quote of the Day- "From the House's Mouth"

“One hundred and seven less homes sold this March through May than last. If you think about the hundreds of thousands of homes in Rhode Island" – 671,240 dwelling units, according to the U.S. Census Bureau – "that puts the decrease in sales in context." - Cecile Cohen, president of the Rhode Island Association of Realtors. (Providence Business News, July 6th)