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

The purpose of this paper is to re-examine currency swaps as an effective hedging technique for individual asset performance in today’s global real estate market, by considering hypothetical prime office investments across six different cities and five currency pairs. The perspective of a risk-averse, high net worth, non-institutional, smaller-scale Swiss investor is paired with investors from five additional national markets.

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.

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 investor’s 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.

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.

There is no recent academic work on the efficacy of currency swaps in today’s 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.