Revisiting currency swaps: hedging real estate investments in global city markets

Publication Date05 March 2018
AuthorPhilipp Bejol,Nicola Livingstone
SubjectProperty management & built environment,Real estate & property,Property valuation & finance
Revisiting currency swaps:
hedging real estate investments
in global city markets
Philipp Bejol
Düsseldorf, Germany, and
Nicola Livingstone
Bartlett School of Planning, University College London, London, UK
Purpose The purpose of this pape r is to re-examine currency s waps as an effective hedging t echnique for
individual asset perfo rmance in todays global real estate mark et, by considering hypothetical p rime office
investments across six different cities and fiv e currency pairs. The perspective of a risk-ave rse, high net
worth, non-institut ional, smaller-scal e Swiss investor is pai red with investors from five additional
national markets.
Design/methodology/approach The study examines currency swaps in key office markets across
three continents (Frankfurt, London, New York, Sydney, Warsaw and Zurich) and extends previous work on
the topic by adopting both Monte Carlo (MC) and Latin Hypercube (LH) techniques to create stochastic
samples for individual asset performance analyses. This is the first paper to apply LH sampling to currency
swaps with underlying real estate assets, and the validity of this method is compared with that of MC.
Four models are presented: the experience of the domestic investor (no exchange rate (ER) fluctuations);
an unhedged direct foreign investment; hedging rental income and initial purchase price via a currency swap;
and hedging rental income and anticipated terminal value.
Findings The efficacy of a swap depends on the historical framework of the ERs. If the foreign currency
depreciates against the domestic one, hedging the repatriated cash flow of a property investment proved
superior to the unhedged strategy (EUR, GBP, PLN and USD to the CHF). An investor would benefit from
exposure to an appreciating foreign currency (CHF to the EUR, GBP, PLN and USD), with an unhedged
strategy clearly outperforming the currency swap as well as the domestic investors performance, while a
historically sideways fluctuating ER (AUD to the CHF) also favours an unhedged approach. In all scenarios,
unexpected economic or market shocks could cause negative consequences on the repatriated proceeds.
Practical implications This research is of interest to small-scale, non-institutional investors aiming to
develop strategies for currency risk mitigation in international investments for individual assets; however,
tax-optimising strategies and the implications on a larger portfolio have not been taken into account.
Originality/value There is no recent academic work on the efficacy of currency swaps in todays global
office market, nor has the position of smaller-scale high net worth investors received much academic
attention. This research revisits the discussion on their validity, providing contemporary insight into the
performance of six markets using LH as an alternative and original sampling technique.
Keywords International investment, Market uncertainty, Exchange rate risk, Currency swaps, Global market,
Office markets
Paper type Research paper
Recent decades have seen substantial capital flows into global real estate markets, through
both foreign direct investment (FDI) and indirect real estate vehicles. Driven by
diversification benefits (Wilson and Zurbruegg, 2003; Markowitz, 1952) and chasing higher
returns, international real estate investment has evolved in cycles, with country and city
markets typically experiencing peaks followed by periods of stagnation (Barras, 2009).
Irrespective of more recent discussions concerned with market convergence, diversification
strategies between countries generally remain strategically viable (Srivatsa and Lee, 2012); Journal of Property Investment &
Vol. 36 No. 2, 2018
pp. 191-209
© Emerald PublishingLimited
DOI 10.1108/JPIF-04-2017-0026
Received 4 April 2017
Revised 11 June 2017
Accepted 28 July 2017
The current issue and full text archive of this journal is available on Emerald Insight at:
The authors would like to gratefully acknowledge the support of Simon Mallinson (Real Capital Analytics),
Dr Nick Axford, Paul Lunn and Mary Suter (CBRE), who gave us access to their extensive databases.
however, such viability depends on subjective investor appetites for risk, return and real
estate vehicle choice. It is also dependent on the amount of capital available, and typically
global institutions are able to more strategically diversify their investments, especially when
compared with a smaller-scale private investor. However, the potentially troublesome
characteristics of FDI, such as lack of local knowledge, data availability and market
transparency, combined with the illiquid, immobile characteristics of heterogeneous direct
property often result in challenging investment conditions. Consequently, alternative and
evolving real estate investment vehicles, such as securities (Lang and Scholz, 2015; Hoesli
and Reka, 2013), indices (Stevenson, 2000), REITs (Moss et al., 2015), unlisted funds (Fuerst
and Matysiak, 2013) and currency swaps (Worzala et al., 1997; Ziobrowski et al., 1997), have
been the subject of considerable academic discussion in relation to risk trends and return
volatility, and the overarching question of how real estate could be successfully integrated
into mixed-asset international portfolios.
One common hedging method is currency diversification. Following the Modern
Portfolio Theory (MPT), diversifying currency exposure allows rising currencies to
compensate for falling ones, and nets out in countries with correlated exchange rates (ERs)
(Odier and Solnik, 1993; Worzala, 1995). However, for investors with only limited capital to
deploy a currency diversification strategy via a large portfolio of properties might not be an
option. Hedging individual investments, on the other hand, can be achieved through a wide
spectrum of instruments, such as financial derivatives including futures, forwards, options
and swaps. Originally designed for short- to medium-term financial products like shares and
bonds, derivatives can also be used for hedging the currency risk on real estate investments
and a number of studies have explored their suitability ( Johnson et al., 2001, 2005, 2006;
Worzala et al., 1997; Ziobrowski and Ziobrowski, 1993). Despite some success, most of the
products available face considerable drawbacks because of the long-held and illiquid nature
of real estate (Baum and Hartzell, 2012). Nevertheless, financial derivatives, including
forward and future contracts, options and swaps, are powerful tools to hedge currency risk
for specific investments.
ER shifts and fluctuations can also have a significant impact on risk mitigation, returns
and diversification strategies related to investing in real estate (Newell and Webb, 1996;
Worzala, 1995). The purpose of this paper is to specifically examine the efficacy of currency
swaps as a hedging technique in todays global real estate market for individual property
investments. The research considers hypothetical prime/core office investments across six
different cities and currency pairs. As there is no recent academic work on this topic and
much of the research relating to currency swaps has not been further developed or
reassessed following the GFC, this paper revisits the discussion on the validity and
usefulness of currency swaps in the international market. In addition, contemporary insight
is provided into the performance of six city markets, pairing Zurich (CHF ) with Frankfurt
(EUR), London (GBP), New York (USD), Sydney (AUD) and Warsaw (PLN).
The perspective of a smaller scale Swiss investor is adopted to examine the possible
impact of the Swiss National Banks (SNB) abolition of the minimum ER of 1.20 Swiss Franc
(CHF) to the Euro (EUR) in January 2015. This monetary mechanism was introduced in
September 2011 to counteract the overvaluation of the Franc in a period of uncertainty and
fluctuation in the financial markets (SNB, 2015). The abolition of the minimum ER saw the
CHFs value rise substantially against the EUR and other currencies, effectively creating
volatility across a broad range of global financial markets. Combining these factors with the
current uncertainty in the financial and real estate markets relating to political shifts, such
as the Brexit referendum and the American presidential election, this research is a timely
and topical re-evaluation of international investment strategies to mediate ER risk from the
perspective of a risk-averse, non-institutional investor. Although global flows are driven by
institutional investors, private investors, albeit as a much smaller part of the market, are

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