GERMAN REAL ESTATE FUNDS : GEOGRAPHICAL DIVERSIFICATION STRATEGIES

Abstract

Given the significant interest of German funds in geographical real estate portfolio diversification, the aim of this study was to examine German real estate funds, their current diversification strategy and to give recommendations for beneficial future allocations. Due to an increased attention of fund managers to the Asian real estate markets, real estate portfolio diversification in Asia is compared to diversification within Europe. These research objectives have been addressed qualitatively and quantitatively. For the qualitative approach a survey of German real estate fund managers has been conducted. A questionnaire with issues related to geographic portfolio diversification through international investments has been discussed with fund managers. The interviewed managers represented approximately 64% of the total German OEF fund volume at the end of 2008. The quantitative approach has been based on a status quo analysis of German real estate fund’s asset allocations. Accordingly, two sets of countries have been chosen in order to compare the Asian and European region. For those countries, monthly market data from Global Property Research (GPR) over the time period from 1991 to 2001 has been used as a proxy for the returns of direct real estate investments. Using Modern Portfolio Theory (MPT), the currency adjusted GPR index has been employed to analyse real estate portfolio diversification in Asia and Europe. The survey of fund managers showed that apart from investment opportunities identified by market research, a fund’s investment and asset allocation strategy is primarily dependent on investor’s demand: The more conservative the fund’s target group, the more conservative the fund’s investment strategy is. According to the interviewed managers, investing internationally is also subject to country and real estate market related factors such as a stable legal framework, economic strength, beneficial fiscal regulations, exit possibilities as well as sufficient size and transparency of the market. Additionally, foreign currencies need to be hedgeable converting exchange rate fluctuations from a risk to a cost factor. Being a highly regulated investment product intending to attract conservative private and institutional investors, German real estate funds are found to favour direct over indirect investments. This could be one reason why the majority has not entered the Asian real estate market yet, but concentrated on neighbouring countries since these are easier to manage. The results of the MPT analysis indicated differences in scale between Asian and European risk return profiles. Due to specifics of the domestic real estate market such as low return and only insignificant correlation with other countries, geographical diversification through international real estate investments is especially reasonable from a German fund’s perspective. Asian countries are less correlated among each other than their European counterparts. Minimum variance portfolios were calculated assuming a German investor investing in the previously determined two sets of countries representing the Asian and European region. The calculations yielded similar linearly increasing efficient frontiers with the only difference that investments in a portfolio containing Asian property allows for more extreme risk return combinations (assuming that lending is not possible). It was found that a “cherry picking” investment strategy selecting the best performing countries out of each region produces the most beneficial risk return tradeoff. The results of this thesis recommend diversifying a real estate portfolio into the best performing countries across regions instead of concentrating on one continent only.