Another Take on Real Estate's Role in Mixed-Asset Portfolio Allocations

Abstract

This article examines real estate's role in institutional mixed-asset portfolios using both private- and public-real estate indices, as a means of examining varying real estate-related risk/return opportunities. In so doing, this article also examines the effects of: (1) increasing the investment horizon, (2) placing constraints on the maximum allocation to any one asset class, and (3) varying the risk preferences of investors. The empirical results suggest—using infinite-horizon returns and all of the caveats that accompany such a perspective—that real estate allocations of approximately 10–15% of the mixed-asset portfolio represent an upper bound for most investors. For those investors preferring low-risk portfolios, (unlevered) private real estate is the vehicle serving this allocation preference; for those investors preferring high-risk portfolios, public real estate (with its embedded leverage of 40–50%) is the vehicle serving this allocation preference—with such vehicles serving as substitutes for a variety of noncore real estate strategies. In some sense, the distinction between private and public real estate is more about the use of leverage. For those investors preferring moderate-risk portfolios, an intermediate-leverage approach seems optimal.