Private and Public Real Estate: What Is the Link?

Abstract

Equity investments in commercial real estate are made through private transactions or public markets. Private and public investments include core real estate—the passive management of existing income generating properties—as well as value-added and opportunistic investments that focus on the active development of existing and new properties. Both forms of investment provide exposure to the same property market. Yet by conventional measures, public and private investments offer surprisingly different return and risk profiles. In this article, the authors focus on equity investment in core real estate in the U.K. market, analyzing data spanning more than two decades. They demonstrate a strong link between the returns to public and private real estate by correcting for appraisal smoothing and for the lead–lag relationship between public and private returns. They also discuss how real estate risk changes over longer horizons. In particular, the correlation between private and public returns strengthens as the investment horizon increases. These results have important implications for both risk management and asset allocation. As an example, they illustrate how the diversification benefits of real estate depend on the investment horizon and the amount of leverage employed.