US Pension Fund Wants to Invest Abroad

Foreign real estate investment is a diversification strategy beyond the domestic markets. Study shows that foreign real estate can be a highly profitable venture in the long term and create passive income (Rogers & Koh, 2017). However, many real estate investors make a common mistake of skipping due diligence when adding foreign investment to their portfolio. This strategy report provides fundamental strategies that US public pension fund (PF) must consider before allocating the new $5 billion allocations to foreign real estate.

Geographical Allocation Strategy and Recommendation

PF should focus on investing the $5 billion foreign real estate allocation in multiple geographies instead of a single country. Focusing on a single country overseas limits the investor to a narrow window of real estate cycles, subjecting the portfolio to unwarranted risks such as political or natural circumstances. Considering multiple geographies can help the investor smooth down knocks in economic cycles and global real estate. Political stability is a critical determining factor in foreign direct real estate investments (Salem & Baum, 2016). Since the political environment is unpredictable, diversifying the company’s portfolio to multiple geographies is critical to avoid such risks.

However, before deciding to invest in the selected regions, it is essential to conduct due diligence on the countries’ culture and customs within the geography as they may lead to a rude awakening. PF should send a team of experts, real estate professionals, market analysts, and legal experts to understand what drives the local life because this will impact the future value and profitability for the investment (Garay, 2016). The company must also work with credible and well-reviewed local real estate professionals who have done business in the locale of interest to provide more insights into market dynamics. Such include mortgage experts, contractors, and property managers familiar with the region.

Sectoral Allocation Strategy and Recommendation

The best way for PF to diversify its portfolio in foreign real estate markets is to invest in an attractive niche. This is important in foreign real estate investment since the company aims to tap into the most lucrative sector in the market from the start (Garay, 2016). Many developed countries are shifting towards sustainable real estate development. Hence, PF should consider investing in the green niche to exploit the emerging trends in the industry and attract more local buyers. Another area to diversify to is the luxury homes market. Luxury is one of the markets least impacted by economic fluctuations (Jiang, 2021), hence the best niche for foreign firms. It also has higher per-transaction commissions, making it one of the most profitable niches in the real estate industry.

Both green real estate and luxury homes niches are only attractive to developed countries because of the costs, and a company with an interest in developing economies should not consider either of the options (Zheng, Wu, Kahn, & Deng, 2012). PF can also target developing economies but focus on niches such as apartments and single-owned homes, which are rising in developing countries, mainly because of increased demand for housing. Choosing the right niche secures the company’s position in a sector with fewer competitors and numerous long-term potentials for development (Garay, 2016). In this area, extensive research is also necessary, working with local and foreign experts to understand the most promising niche.

To Hedge, Or Not To Hedge

Foreign real estate investors are exposed to currency risk as their portfolios become more globally diversified, and PF is not an exception. PF will have varieties of global benchmarks as a foreign investor at property and fund levels. If the company chooses to invest in property assets, the location of the properties, transaction currencies, and rent received all pose currency risks. If PF decides to invest through funds, each fund still has a reporting currency that exposes the investor to currency risk. Hedged indexes can help either case, allowing investors to align benchmarks with their hedging policies (Garay, 2016). Currency hedging will help PF reduce some transactions and translation risks.

Overall, location is a crucial factor when choosing real estate investment. PF should consider investing in multiple geographies to diversify the real estate portfolio and reduce geographic risks, such as natural and political risks. One sectoral allocation, PF should consider supporting attractive niches such as green real estate and luxury homes, which are on-demand in developed countries. Currency hedging is important for PF to reduce transaction and translation risks in the global market.

References

Garay, U. (2016). International Real Estate Investments. Garay, U.“International Real Estate Investments.” In Kazemi, H, 451-477.

Jiang, W. (2021, June). Impact of Covid-19 on the US Real Estate. In 2021 International Conference on Enterprise Management and Economic Development (ICEMED 2021) (pp. 65-69). Atlantis Press.

Rogers, D., & Koh, S. Y. (2017). The globalization of real estate: The politics and practice of foreign real estate investment. International journal of housing policy, 17(1), 1-14.

Salem, M., & Baum, A. (2016). Determinants of foreign direct real estate investment in selected MENA countries. Journal of Property Investment & Finance.

Zheng, S., Wu, J., Kahn, M. E., & Deng, Y. (2012). The nascent market for “green” real estate in Beijing. European Economic Review, 56(5), 974-984.