Diversification Benefits of U.S. Real Estate to Foreign Investors

Substantial empirical evidence has been offered that supports the notion that international diversification enhances portfolio performance. Another large body of research suggests that the addition of real estate to pure financial asset portfolios also provides improved mean-variance efficiency. Thus, it is logical to hypothesize that the greatest gains are available from international mixed-asset portfolios that include both foreign financial assets and foreign real estate. This study investigates this hypothesis as an explanation for the large purchases of U.S. real estate by foreign investors. The results indicate that U.S. real estate does not improve foreign portfolio performance. The evidence suggests that volatile exchange rate fluctuations induce a level of risk in these assets that offsets any potential diversification benefits to foreign investors.