Real Estate Diversification

Investing in real estate is no straightforward matter. Markets need to be researched, capital is required, and competition is high. Needless to say, it is possible. A good starting place is acknowledging the benefits of diversification. In doing so, investors increase their returns whilst minimising the risks associated. One approach is diversification through countries.


So, how can diversification through countries work when investing in real estate?

The first step is having clear objectives. This includes knowing how much capital investors are ready to deploy, what is their investment horizon, what risk levels are they willing to take, and so on. Once the objectives have been made clear, research must be conducted. This will include understanding the current state of the global economy, how are global real estate markets performing and how they are performing amongst each other. Whilst in the early stages in the investment process it is worth taking a broader perspective on the research. Once the investors have created a clear picture of the broader market they can start with more in-depth research. At this stage, investors would create a shortlist of potential markets to enter, say a list of 10. The countries selected would need to correspond with the initial objectives. ie. developed countries or high-risk countries. A potential method of making a selection of the shortlist would be through creating a performance matrix. This can be based on a set of different criteria. This will help investors gain a better understanding of different countries’ tax laws, its valuation practices, whilst understanding the current state and future prospects of the respective markets.

Investment Performance Matrix

Each criterion would be ranked from low to high (eg numbered from 1 to 5). Below is an example of how the countries would be identified.

Countries Performance Matrix

Once a set number of countries have been selected, investors would move from qualitative to quantitative research, where the figures of the respective countries must be analysed. Formulas will include Returns, Averages, Standard Deviations, and Correlations. These returns will provide a better understanding of how real estate has performed recently, the volatility of specific markets, followed by understanding how correlated they all are. Whilst returns and volatile will provide a risk/return profile for each respective market, the correlation will demonstrate how diversification can come in to play. This would be limited if not taking the analysis to a further extend through creating an efficient frontier, and a Sharpe Ratio. These will provide a much better representation of the correct allocation for each market, how much risk will be reduced, whilst simultaneously maximising returns. It is worth noting that whilst historical data demonstrates a good indication of the market, it cannot be relied upon for future outcomes. Whilst qualitative and quantitative research are essential in providing an indication of an investment portfolio, instinct will also play its part, as one cannot predict future returns of the markets.

Once the portfolio has been allocated, the fund would start its investment process. It is worth noting that it will be hard to invest solely in direct real estate. That is as real estate is illiquid, it has limited availability, and it requires a large sum of capital. Alternatives methods include open-ended, close-ended funds or listed real estate companies. Understanding the different types of investment vehicles requires a research analysis in itself.

This has been a brief outline/ analysis demonstrating the complexities of diversifying in real estate. It has only covert some aspects as it has not expanded on the investment vehicles or statistical approaches, whilst not even mentioning real estate sub-sectors or real estate’s correlation with the general economy.

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