Our research shows investors can improve the risk/return profile of balanced portfolios by allocating to global listed real estate. We believe one of the more thought-provoking findings is that listed real estate's liquidity characteristics – real estate stocks can be bought and sold easily – have allowed investors to continue investing in real estate despite the recent financial market volatility.
The search for the highest possible portfolio returns has intensified in recent years as expected returns on risk-free assets have plunged. Real estate has come more sharply into focus as portfolio strategists recognise its attractive income and overall returns.
Against this backdrop, we have assessed whether listed real estate can improve the risk and return characteristics of a multi-asset portfolio, using a robust optimisation technique.
Our research shows that including listed real estate in an allocation can improve returns dramatically without increasing volatility. Exhibit 1 shows the optimal listed real estate weight is almost 9%, improving the Sharpe ratio by a significant 14%.
Should REITs be included in institutional real estate portfolios?
One of the most persistent investor criticisms of listed real estate is that over the short term, these stocks behave like other equities and are just as volatile, while direct property markets and stock markets are uncorrelated, making the direct sector a portfolio diversifier, while listed real estate is not.
On the whole, academic research into the relationship between the performance of listed and direct real estate investment suggests that the returns from both asset classes are comparable in the long run. We agree. Listed real estate companies manage properties and collect rents and their capital expenditure and development costs are similar to those of unlisted real estate companies. The value of listed real estate companies is affected by the same changes in property markets and values over the long term.