Real estate funds offer diversity, but are they too hot?

In the past year, a host of fund companies have started offering real estate funds — a product made up of real estate stocks and REITs. Interest seems to be high. But with a rising dollar, sub-prime problems in the States and a general notion that the market has peaked, is now a good time to get into the real estate market?

“When we see housing prices start to bottom… that translates to losses in real estate funds,” says Peter Ficek, a Calgary-based CFP. “Is everybody jumping on the bandwagon now, only to see a couple years of bad returns?”

In the past few years, real estate has been performing well, which has translated to big returns — up to 40% — for some real estate funds. But Ficek points to higher interest rates and a slowing American market as reasons that it might not be best to put all your eggs in the property basket. “We may have already seen the best of the market,” he says. “If the U.S. is an indicator of where our asset prices are going, it has already seen some downturn. Interest rates are creeping up too. What would happen is the cost of borrowing goes up and that slows down the economy, including real estate.”

For some advisors, the thought of a tanking real estate market brings back memories of the late 1980s, when real estate funds were all the rage. Many investors had put money in these funds and lost a lot of it when the real estate market crashed.

“It was pretty severe,” says Dan Hallett, president of Dan Hallett and Associates. “There was a lot of leverage at play so it came crashing down fairly hard. That prompted a lot of people to pull out of their real estate funds. I’m not even sure how investors escaped all of that.”

It’s unlikely that something that devastating would happen again — the real estate funds of the 1980s were invested directly in property rather than in global stocks — but a market downturn is still a concern.

Proponents of real estate funds don’t anticipate any type of crash, even though the North American housing sector is at a crossroads. That’s because most of the new real estate funds are global, and the majority of investors own stocks and REITs that deal in commercial real estate.

“You have to be aware that the housing market may not necessarily reflect what’s going to happen in the commercial real estate space,” says Christine Girvan, CEO of ABN AMRO Asset Management in Canada, which operates Mackenzie’s real estate funds. “You might be invested in an office tower in the U.K. or a retail mall in Hong Kong.”

She adds that it’s important to look at the broader dynamics of each country’s economy when determining the sector’s volatility.

Girvan also points out that when Mackenzie, which has about $262 million in its Universal World Real Estate Class Fund, is looking for places to invest, it pays attention to the amount of construction going on in each country. If there are too many office space options, that city or country might not provide good returns. “That will influence how landlords are going to be able to increase their rent.”

Looking at real estate from a global perspective is the main selling point for these funds. Not only does a global outlook allow for more diversity, but investors are able to get into real estate markets typically reserved for the Trumps of the world.

“There are a couple dozen countries around the world that have large liquid property sectors,” says Gavin Graham, CIO of Guardian Group of Funds, which recently introduced a real estate fund.

Graham says that global real estate doesn’t have a high correlation to other asset classes, including equities and other real estate. “Japanese apartments have nothing to do with German shopping centres, which have nothing to do with London offices. So you’ve got something that’s not correlated with most of the other traditional assets in other countries.”

While Hallett thinks investing directly in property is the best way to get in the real estate market, buying a real estate fund — especially a global one — isn’t a bad alternative. “In the long term, you’ll benefit from real estate as an asset class, but by going global, you’re benefiting from some diversification against the Canadian markets as well.”

Still, like anything, if the markets don’t do well, the funds will lose value. “If real estate stocks are part of the Composite Index, invariably it’s going to be impacted for better or worse by the general ups and downs of that market,” says Hallett. “So you’re losing some of the diversification in shorter and intermediate periods.”

If your client is keen on investing in a real estate fund, Ficek says not to let it exceed more than 10% of a portfolio. “If you’re going to have a diversified portfolio, you wouldn’t want to take a bet on any asset class,” he says.

And like any asset class, when something gets too popular, it’s worth asking yourself if now’s a good time to get in the game. “When times are good, everyone jumps on the bandwagon,” says Ficek. “Maybe this is happening right now with the real estate market performing so well.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(08/03/07)

Bryan Borzykowski