While REITs obviate the need for investors to wrestle with analytically intractable and illiquid individual properties, they have several drawbacks. One is investors’ lack of control over the REIT investment portfolio. REIT managers compensated on the basis of their fund’s returns may flock to the top-performing property markets, giving their investors, perhaps without their knowledge, a dangerous concentration of exposure to a handful of countries. "When these REITs do get set up in Europe and other emerging economies in the near future, we are expecting a lot of the money to come here to the U.S.," explains Dan Fasulo, director of the market analysis group at Real Capital Analytics, a New York firm that tracks the commercial real estate market. "At the end of the day, a British REIT could end up having 50 percent in U.S.-based properties," he warns.

Another significant drawback stems from the fact that REITs are equity stakes in portfolios, not the portfolios themselves, and so are subject to the vicissitudes of the equity markets. Investors attracted to real estate because of its low correlation with traded equity, cash and fixed-income investments may be disappointed to find that technical market factors (essentially, supply and demand imbalances and broad market up- and downdrafts) impinge on the daily values of REITs as much as any tradable stock. "Investors need to be aware that REITs are far more volatile than their underlying assets," notes Iain Reid, chief executive of property investment company Protego Real Estate Investors in London. (Click images to enlarge)

"A very small proportion of the total stock market is invested in REITs, and so they can get wagged by the broader investment market on occasion," agrees Deutsche Bank’s Hobbs. However, he adds that REITs differ enough from standard equities in their fundamentals and asset characteristics to make their correlation to the broader market relatively low, at least for the moment.

Analysts at Ibbotson Associates, a Chicago capital markets research firm, found that the correlation between U.S. REITs and small-cap stocks in 2004 was around 0.26 (a correlation of one indicates that the two markets move in lockstep; a figure of zero indicates they are completely unrelated). However, the correlation between the two asset classes was as high as 0.9 in the late ’80s.

INTERNATIONAL ALTERNATIVES
VEHICLE		PROS	CONS	RETURNS
REITs		• Very liquid. • Low correlation with individual equities. • Low fees. • Market pricing	• Significant correlation with broad equity markets. • Equity market volatility.	• Global average outperformed equities by a factor of five since 2001.
Private Equity Property Funds		•Management by pro-fessionals with signifi-cant local market knowledge. • Reasonably liquid (lock-ups of 1-2 years).	• Annual management fees of 1-3 percentage points. • Asset valuations are not always transparent.	• Varies depending on quality of manager; in high-growth markets, competent managers may see 15-30 percent annual returns, though with significant market risk.
Syndicated, Bespoke Transactions		• Potential for very high returns.	• Illiquid (must wait for entire syndicate to agree to sell). • Fees are not often transparent. • Lack of diversification leaves investors with significant market risk.	• Varies depending on market and competence of manager or lead investor.
Direct Investment		• No intermediary to pay. • Potential for very high returns.	• Major commitment of time and effort. • Complete exposure to property market risk.	• Varies depending on market and competence of investor.
Derivatives-based Structured Products		• Potentially liquid market with transparent market valuations of underlying asset portfolios.	• Nascent market, concentrated on European assets. • Fees not transparent. • Complexity risk.	• Returns on existing products (around 6 percent) are not spectacular.