December 2, 2013
Interviewed by: Privcap
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Franklin Templeton’s Jack Foster: Global RE Portfolios

Investing in emerging markets requires investors to underwrite not just a GP, but the entire country. Jack Foster of Franklin Templeton Real Asset Advisors argues such diversification is a must for LPs.

Investing in emerging markets requires investors to underwrite not just a GP, but the entire country. Jack Foster of Franklin Templeton Real Asset Advisors argues such diversification is a must for LPs.

Building a Truly Global Real Estate Portfolio

With Jack Foster of Franklin Templeton Real Asset Advisors

Zoe Hughes, PrivcapRE:

I’m joined here today by Jack Foster of Franklin Templeton Real Asset Advisors. Thank you so much for joining us and welcome to PrivcapRE.

Jack Foster, Franklin Templeton Real Asset Advisors:

Well, thank you for having me. This is great.

Hughes: Franklin Templeton is well known for investing in emerging markets and with smaller emerging managers. When it comes to looking at the emerging markets, what is the importance and why should investors be looking at creating a global property portfolio?

Foster: In some ways, we have been investing in emerging markets since we started over three decades ago because many international investment opportunities were new to domestic investors. We found that real estate is very interesting in the sense that it’s locally priced. It is a commodity like oil, gas or gold, but the pricing of those commodities is global. Real-estate pricing is local. You pick up, arguably, some of the best diversity by investing outside your domestic market. That’s where you begin.

There are challenges with real estate. One big one is hedging: direct real estate is expensive. Over time, we have gotten investors to try to find investments overseas (depending on your country) that are creative to your domestic returns and expectations. Sometimes, you look for a bit higher risk and those have emerged over the last 20 years and higher returns for that risk of going overseas. In some ways, the idea of going international is challenging for many domestic investors because real estate is one of the most personal asset classes; everyone has a strong view on real estate because most people want to own a home and, for most people who own a home, the majority of their net worth is there. Therefore, people have strong opinions about domestic real estate. But if you compare real estate to equities or bonds, you would never limit your portfolio to a domestic bond strategy, or domestic equity strategy. Real estate has been the last asset to be globalized and there are great opportunities because of that.

Hughes: When you look at the opportunity setting, commercial real estate today, the U.S. is one of the best places to be investing. There is a plethora of deals. Domestic investors are keeping their eyes on the U.S. When they are faced with that amount of opportunity, why even begin to look outside the U.S.?

Foster: Yes, there are great opportunities in the U.S., especially coming out of a global financial crisis. We have seen a real shakeout; a number of emerging managers look to be great opportunities in the U.S. There is no question, but from a long-term portfolio construction point of view, diversification is important.

It is not easy to get diversification out of the gate with real estate. There is no clear index, which is why real estate is falling into that alternative asset bucket because it’s hard to get the same diversity and liquidity you can achieve in bonds and equities. However, there are great opportunities outside any domestic market. The U.S. investor is in one of the larger markets with one of the deepest opportunity sets, but if you are an Australian or French or Hong Kong investor, the idea of going out of your domestic market makes sense to capture some other returns and diversity around the globe.

Going back to my comment about locally priced (real estate), the argument becomes a lot clearer. If I can capture economic activity in U.S., there is a reason it captures some economic activity in other markets. I agree—it’s challenging for investors to think outside the box and say, “Hey, there’s more real estate than in just my country.”

Hughes: When you look globally, where do you see the most compelling opportunities?

Foster: There are opportunities around the world. Let’s start with the U.S.: clearly, the opportunities are in major urban areas, east and west coast, and especially Texas, where we have a wave of revenue tied to oil and gas. Those opportunities are emerging out of the global financial crisis, where there was mispricing and over-leverage. There is real distress in these markets, but at the same time, we are beginning to see real economic growth and opportunities across subsectors within real estate.

As we move overseas, there are opportunities in Europe. It has been a challenging market. The challenges in southern Europe are significant, whereas in northern Europe, there are more opportunities, though the market is a bit thinner as you go north into the Nordics. The U.K. has been on a tear and there will likely be some real pricing opportunities, not just in London but further outside London as well. Going into Eastern and Central Europe, the markets are very thin, they moved up quickly before the GFC and they are working through those issues. As we see more of those countries come into the EU, they will be great.

Asia is interesting because the markets have shorter cycles. Japan is a real anchor for the region and, with the changes in their economic policy, the Japanese market is going to do well. We will see some inflation there, which means we will see rents move, and there are opportunities in that market as the banking system removes some distress.

Looking further abroad in Asia, into a number of smaller markets, the challenge of finding an excellent manager in those markets becomes greater as you look in the Philippines and Thailand, but there will be great opportunities in those markets. China is a big market, with a lot of moving parts, but the Chinese government has made a clear statement that they will support their population by supporting real-estate values. They don’t want a bubble, they have worked very hard to prevent that, and they are doing a good job, so we see opportunities in China as well, across asset classes.

Hughes: I want to pick up on some of your activities and how you pick the right partner to invest with, particularly in Asia. With frontier markets, are you considering looking further outside, at the more established markets of Japan and China? Are you looking at those that could be deemed “frontier?”

Foster: Absolutely. You need to look in those frontier markets and find a very good partner. A huge amount of work goes into underwriting your partners in those markets because of the risk. We put a great deal of time into it. One market getting a lot of attention is Myanmar. This market has come out of and changed to a different public or political structure. As you begin to look at those markets, you first have to check with your clients: is this market on their buy list? Can they actually own properties in that country? That’s where you begin. Africa may offer a huge opportunity but it is very different. Many people consider Africa but its many different countries have different political risk. When you go to emerging or frontier markets, you begin with a legal structure. What is your opportunity to invest capital and remove capital legally?

Just as important is taxation. Taxation for real estate is not homogenous around the world, unlike stocks or bonds. Therefore, you need to have a firm grip on the tax liabilities for your clients.

Hughes: It’s not just about underwriting a GP and the right operating partner, but how do you begin to underwrite a country for investment? What research do you do when looking at Africa or other frontier markets?

Foster: We may not be the first mover, but we will certainly understand the risks. I mentioned legal risk: is there a rule of law we can bank on? Is it a country where legally, our clients can invest in? That is where we begin.

From there, you must have a firm view on the macroeconomic environment. If you are going to a market where the environment has improved over the last several years, you want to make sure your partner—who you will put even more emphasis on—is able to face the challenges of that emerging or frontier market. Having a firm view of the macro, understanding the history of the country, the political risks—these are all factors that can go into your decision. The biggest challenge for real estate is that it’s not as fungible as equities or bonds, where you can move your capital out of frontier markets in reasonable time. Generally, you are making real-estate investments for five years plus.

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