In a late-stage property cycle, institutional investors are having to become more sophisticated about portfolio diversification.

Many institutional property investors have a bias towards domestic assets and would benefit from more global diversification, but the solution to this isn’t simply investing in big “gateway cities” like London, New York, Berlin or Paris, Stefan Wundrak, head of European research for TH Real Estate, said.

These major cities are highly interconnected and their growth tends to be correlated, he said.

“They are all based on business and financial services, and with a hit to the global economy like the GFC, they all react very similarly,” Wundrak explained.

In seeking “proper diversification”, investors should consider cities that follow a different economic pattern, he said. These could include Toulouse in France, which is “a back-office location for the French state”, Gothenburg in Sweden, which is the biggest seaport in the Nordic countries, and Stuttgart in Germany, which has a well-developed manufacturing industry.

Wundrak was speaking at the 2018 Conexus Financial Real Estate and Private Markets Conference, held in Melbourne last month.

In a panel chaired by StepStone Group partner Brendan MacDonald, Wundrak said investors often make the mistake of talking about diversifying via countries. In reality, it is more important to do the numbers on individual cities, he said; for example, the UK has some of the fastest-growing cities in Europe but also some of the slowest.

Also, investors might also think of emerging markets in Asia if they are looking for the greatest growth, but Eastern Europe has 41 of Europe’s 50 fastest-growing cities.

“There is clearly quite a sizeable emerging-market opportunity, even in a place like Europe, which doesn’t have the global megacities that Asia has and will have,” Wundrak said.

Padraig Brown, head of real estate, Pacific markets, for Mercer Investments, said many Australian investors are heavily invested domestically and could benefit from moving outside their “traditional comfort zone”.

“There are cities that may not be rolling off the tongue but have very strong local growth stories,” Brown said. By teaming up with good local managers, investors can access markets and do deals before the wider market spots that growth.

He warned, however, that in this late stage of the business cycle, with many investors searching for yield and return, risk can often be mispriced.

“It is a great market to sell assets into to unsuspecting return hunters,” Brown said. “You really have got to know those markets.”

MacDonald asked the panel if this wasn’t simply “classic late-cycle behaviour”, with investors searching for yield by pushing into suburban and secondary markets and buying relatively new product types such as senior and student housing, which traditionally wouldn’t have a place in a core institutional portfolio.

“How do you consider the risk of them being stuck in those markets when, say, capital markets do face a downturn?” he asked.

Suzannah Cockerell, senior investment analyst for First State Super, said research into long-term supply/demand dynamics was key. First State Super has done much research and invested into retirement villages in Australia, she said.

“Maybe it’s not super liquid right now but we are prepared to hold it for 10 years and we think there is room to run,” Cockerell said.

Ben Hurley is a journalist and editor with more than a decade of experience in the industry. He has written for The Australian Financial Review, Business Review Weekly, The Guardian and a range of specialised and industry publications.