Abstract
Executive Summary. It has been more than a decade since researchers first raised the spectre of smoothing for appraisal-based real estate return series, suggesting that real estate risk had been grossly underestimated. Since that time, a number of studies have presented evidence which argued that, even with significant additional risk, real estate still offered investors substantial diversification benefits.Unlike earlier studies, which constructed only a few isolated optimal portfolios and measured the effect of higher real estate risk on portfolio composition, this study constructs full efficient frontiers and directly measures the impact of higher real estate risk on mean-variance performance at all levels of investor risk preference.The results indicate that additional real estate risk of a magnitude consistent with rational appraiser behavior can have a negative impact on mixed-asset portfolio performance. For investors with a low-risk tolerance the higher levels of real estate risk can eliminate all real estate diversification benefits.
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