"Think globally. Act locally." This slogan from the 1970s holds new meaning for the world of real estate investments. Investors who want to diversify, seek a stable income source and want equity exposure to real estate markets should consider investing in global real estate investment trusts (REITs).

REIT Review

REITs are real estate stocks that trade on major exchanges. They invest directly in office, retail, industrial, apartment and other income-producing properties. So long as REITs distribute at least 90% of income to investors as dividends, they are not subject to corporate taxation. (This is the distribution percentage for the United States. The percentage may vary in other countries.) As such, REITs offer investors an efficient way to invest in commercial real estate. They typically offer attractive yields and superior liquidity to investing in property directly.

Introduced in the United States in 1961, REITs hit their stride in the early 1990s. From less than $10 billion in equity market capitalization in 1990, REITs have grown to more than $300 billion in 2007. To be sure, many investors have been attracted by stellar returns for the sector. As of July 31, 2007, U.S. REITs in the broad-market Russell 3000 Index returned an annualized 12.2% over the past 10 years. Over the past three years, domestic REITs' annualized return has been greater than 15%. These returns incorporate the major correction in the domestic REIT market that started in February (U.S. REITs were down 21.6% during the period from Feb. 1 to July 31, 2007).

The M&A Squeeze

Blackstone Group's private buyout of U.S. office building owner Equity Office Properties Trust for $39 billion in February ranked as the biggest takeover of a real estate company and one of the largest private equity deals ever. Fueled by strong demand from private equity real estate buyers, this transaction capped a merger-and-acquisition trend that has dominated the U.S. REIT market over the past two years.

Opportunities for real estate investing in the United States are now becoming more limited as a result of consolidation in the number of REITs. While merger-and-acquisition activity is generally a positive sign of a dynamic marketplace in any industry, concentration in the U.S. REIT market is increasing; in 2006 there were some 18 deals and 10 so far have happened in 2007, worth a combined $100 billion in equity value. If this trend continues, many investors will look beyond U.S. borders to place incremental allocations of capital to REITs.

Trends to Consider

While growth of the domestic REIT market is flattening out, global REITs are in the early stages of their growth cycle. Increased numbers of countries with REIT structures, merger-and-acquisition activity and cross-border investing indicate that global REITs are on the rise.

New REITs. More countries are offering tax-efficient REIT structures. In addition to the mature REIT markets of the United States, Canada, Australia, the Netherlands and Belgium, REITs have recently been introduced in a number of other countries, including France, Hong Kong, Japan and Singapore. The United Kingdom launched REITs on January 1, and Germany and Italy are expected to follow suit later this year. This activity is stimulating growth in the securitized real estate sector in these countries, including several initial public offerings.

Cross-border investing. Transfers of assets from corporate and government owners is driving property securitization on a regional basis in Europe and Asia. In smaller markets, such as Australia, where there is a limited supply of high-quality domestic real estate and a high level of securitization, real estate investors are looking to North America, Europe and Asia for opportunities to place capital.

Westfield, for example, is an Australian shopping center development company with the majority of its $28.9 billion invested in assets outside its home country, including shopping malls in the United Kingdom and the United States. Other well-regarded companies with active cross-border investment programs include ProLogis, a U.S.-based industrial REIT with development activities in Europe and Asia; Unibail-Rodamco, a French-based REIT with a diversified portfolio of Pan-European properties; and Hongkong Land Holdings, which invests in office properties in various major Asian markets.

Pros and Cons

Investing in global REIT structures offers investors the benefit of diversification. Real estate markets around the globe are affected by supply and demand factors that are highly localized. Because the correlations of returns between international markets are relatively low, even lower than for global equities, there are significant diversification advantages of investing in REITs on a global basis.

On the other hand, many global REIT funds are fairly young, with limited performance histories on which investors can base decisions. And global REIT investors experience some of the same risks as those who invest in international stocks—geopolitical issues, limited public information and less liquid trading.

Evaluating Investments

Despite the drawbacks, global REITs could be the right investment for some. So how can financial planners evaluate these REITs? As with any stock, planners should study the quality of management, clarity of the investment strategy and history of dividends and dividend growth. With REITs, it is also important to understand where the company owns assets, along with the investment fundamentals in those markets.

For example, REITs that hold office properties in the top three domestic markets—New York, Washington, D.C., and southern California—may sell at a premium, but could still represent a good investment opportunity based on growth prospects. The same is true of leading non-U.S. markets, such as London, Paris and Tokyo.

Despite the recent volatility in various international markets, the fundamentals appear to be in place for global REITs to experience some of the same success that has been enjoyed by domestic REITs. While all investments carry a certain amount of risk, now, indeed, may be the ideal time for you and your clients to think globally.

Bruce Eidelson is director of real estate portfolio management fo the Tacoma, Wash.-based Russell Investment Group. He has been at Russell since 1999.