Global Real Estate Diversification

You Can't Afford The Risk Of Not Diversifying Globally

Sept. 9, 2011, Ceara, Brazil: I want to diversify into international real estate, but I just can't justify it because I'm getting yields from property investments in the United States that are as good as I could get overseas, and the transaction costs in the United States are lower.

Dear Overseas Opportunity Letter Reader,

A reader wrote this week to say, "I want to diversify into international real estate, but I just can't justify it because I'm getting yields from property investments in the United States that are as good as I could get overseas, and the transaction costs in the United States are lower."

That is one way to look at it.

On the other hand, if you're into residential rentals in the States and in the States only, for example, the risks are not insignificant, given both the current market climate and the lack of portfolio diversification.

Over the years, many readers have told me similar stories. They had great portfolios of rental houses or apartments, they explain. All their properties were returning at breakeven cash flow or better. So they'd been systematically expanding their holdings within their target markets.

Then, in some cases seemingly overnight, the local market where they'd been investing shifted. Maybe the economy for the entire city turned, with jobs being lost and people moving away. Maybe the demand for local housing changed, with new neighborhoods opening up and fewer people wanting to be in the neighborhoods where the investors held their rentals.

The end of these stories is always the same. The investors lost everything, sometimes walking away from mortgages they could no longer cover. Once even just some of their rentals weren't occupied, they couldn't make their loan payments, setting off a domino effect that eventually affected their entire portfolios.

The fundamental problem is lack of diversification. All the holdings in each case were in single cities or regional markets. When bad times hit, the portfolios were wiped out. Even if these investors had diversified regionally within the United States, their portfolios overall could have been less at risk...at least until the recent U.S.-wide real estate market collapse.

On the commercial side, U.S. triple net lease properties are earning net yields between 6.5% and 8.5%. And you can find higher cap rates with lower quality locations. Of course, these kinds of property investments come with high costs of entry, with prices starting typically at around US$1 million. Even with bank financing you're looking at an investment of a couple of hundred thousand dollars. In addition, many of these properties are in what I consider risky locations. Sure, you may have a lease with a well-known national company, but that doesn't mean there's no risk of the business at your location closing. As many of these properties are purpose-built for a specific business, finding another one to take the space can take time.

I'm not saying you shouldn't include residential rentals or triple net lease properties in the States in your portfolio. These can still be good ways to earn respectable yields. What I am saying is that you shouldn't exclude international real estate from your portfolio because you think you'll net 1% or 2% less outside the States after transaction costs have been factored in.

Furthermore, remember the other side of your total return--potential capital gains, which can be dramatically greater in developing and emerging markets than you can expect them to be in the United States (especially right now).

Yes, transaction costs for real estate in many countries are higher than they are in the States. Leverage isn't available in most global markets (which can be a good thing in the long run in terms of risk but increases cash requirements). And you'll have to spend time and money traveling to the places where you invest (on the plus side, this is a chance to write off vacation expenses).

But you've got to keep the big picture in sight. The idea is to build your wealth in a manner that protects it long term.

International real estate can do that while also giving your family a layer of protection should things go south back home.

Lief Simon

Editor's Note: Lief Simon is Editor of Global Property Investor's Marketwatch, a global real estate investment service to guide you as you diversify your portfolio to include real property assets and reliable yields. Read more here.

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