W ith real estate becoming an increasingly relevant asset class in many institutions’ portfolios, cross-border real estate investing is also becoming more popular. Many European-based institutions are rethinking strategies on real estate. Some are entering the real estate market for the first time; others are seeking to diversify domestic portfolios by entering the international market. Investment theory, fuelled over the past few years by a rapidly evolving research effort on real estate, may support these institutions in making decisions on all issues concerning allocation, including timing;ways of investing (directly affecting their own staffing requirements); size, geography, sector and risk premium.

The allocation to US real estate
One route that many investors have taken is to diversify real estate portfolios geographically. European investors have invested in the US for four primary reasons:
q The US offers a vast amount of institutional-grade real estate to invest in. Forgoing this greatly reduces the investment universe.
q (Risk adjusted) returns are not always the same over different markets in Europe and the US. This allows investors to time investments and divestments in these markets differently.
q Different markets offer different risk/return profiles. So investors are able to choose the profile that best suits them.
q Most important for many European investors, a US real estate element significantly reduces the risk of their portfolio.
Compared with most European markets, the US real estate market is deep and diverse and also relatively liquid and transparent. Indices are available for the listed and nonlisted sector, the latter being offered by NCREIF.
Next to a large publicly listed REIT market, the US offers a host of non-listed vehicles, ranging from low risk (‘core’ real estate) to more opportunistic products. In addition to equity investment, a broad and deep market exists for real estate debt products.

Ways of investing into the US
Once an allocation to US real estate is established, investors must consider whether they ought to invest in shares of listed companies or invest directly. In the latter case, investors must decide whether they want to own and manage buildings directly or access real estate returns through a local partner. Among several factors, the following to a large extent drive strategy for investing in the US:
q The size of a real estate allocation Probably only a very sizable allocation justifies establishing a local team building a portfolio of directly held assets. Other institutions have a choice of building a portfolio of listed shares, or choosing local partners through which they access real estate returns. The main rationale for this decision is that they want to have a local partner aligned with his own money in the deal. Some Dutch institutions and independent fund of funds managers (such as Mn Services) take both routes and invest through listed and non-listed vehicles.
q Fiscal factors Differing tax regimes between the investing country and the US to a large extent determine the way institutions have invested. And over time, because of changes in legislation, people have been forced to consider different strategies. A deep knowledge of tax treaties between the home country and the US, and also a monitoring of changes in tax legislation are crucial to mitigating negative effects on returns.

Early waves of US investment
The early history of foreign investment in the US is a study of waves. The waves often coincided with conditions in the host countries. Many of the early waves were based on speculation-either in the real estate itself or in currency movements. The US has seen a petrol-dollar wave, a Canadian developers’ wave, a British institutional/developers’ wave, a Dutch institutional wave, a Japanese wave, a German wave and perhaps a new Australian wave. However, the amount of foreign investment in real estate in the US has remained a constant proportion of the total of all foreign investment into the US – about 10%.

A history of foreign investment in US real estate
Dutch and UK pension funds were probably the first foreign institutional investors in the US. Large allocations to real estate and the need to find quality investments led them to the US in the mid-1980s. The US market is large and complex, and the tax laws bewildering to foreign investors. The US Congress had just passed several FIRPTA laws aimed at foreign real estate investors without any advice or consultation with actual investors.
The passage of these laws and the need for an organisation that had non-US companies’ interests in mind led to the announcement in 1988 of a new real estate association in Washington, DC. It was to be called the Association of Foreign Investors in (US) Real Estate (AFIRE) and was devoted to the “guidance, education, and protection of investment institutions located outside of the US that have a unique interest in American real estate”. This was a formal way of saying that AFIRE wanted non-US investors to have the same advantages as US investors.
When the savings and loan crises weakened US real estate markets. many of the funds began withdrawing from the US. UK institutions went back to investing in London. This coincided with the break-up of some of the larger UK pension schemes and with smaller allocations to real estate. The Japanese eventually stopped buying, but generally retained US holdings. The Dutch funds decreased their overall investments and began shifting into securitised real estate.
In 1994, a new Dutch–US double taxation treaty gave favourable tax treatment to dividends received by Dutch pension funds from US REITs. This coincided with an explosion of growth in publicly listed US REITs and the growing influence of this tax structure for US real estate ownership. Foreign ownership of US public REITs was on the rise and Dutch, Canadian and other nationalities’ pension funds began using private REIT structures as well.
The Germans began entering the US markets in the mid-1990s. Because of their investment structures and their own tax treaty with the US, the Germans were not as interested in REITs as in direct ownership. This German wave was not very different than their entry into the other EC countries. In fact, because of legal restrictions, the open-ended funds were slower coming into the US than, say, the closed-end funds. The Germans were known as bond investors – the ideal real estate investment was a single-tenant building with an AAA credit tenant on a long-term lease.
Throughout the rest of the 1990s the Germans dominated foreign investment in the US. However, some of the large Dutch pension funds have continued investing in both private and public REITs. Middle Eastern investment, especially from Kuwait, is growing. Canadians are moving back into the US. And the newest wave is listed property trusts from Australia. These are investing in the US because the superannuation schemes in Australia are clamouring for yield and investment product.

AFIRE is recognised as a prestigious association for international real estate investors, with 155 corporate members from 16 countries. It offers members a host of services and this year will organise conferences in New York, Toronto, London, Frankfurt, Amsterdam and Chicago, providing in-depth, cutting edge information on various aspects of investing in US real estate.
James A Fetgatter is chief executive of AFIRE. Erwin F Stouthamer is director of international real estate with Mn Services in the Netherlands, and is AFIRE’s chairman