Investing in real estate is one of the key ways to diversify a portfolio. It provides an investor with a continuous income stream from rent, inflation protection and potential capital appreciation. In this article, Robeco real estate portfolio managers Folmer Pietersma and Frank Onstwedder present an optimal portfolio framework based on a simulation of historic listed real estate returns.
The largest institutional asset managers have long recognized the added value of real estate in their strategic asset allocation. For example, one of the largest global pension funds ABP – for government employees in the Netherlands, with AuM of EUR 400 billion in 2018 – allocates 11% to real estate. Other institutional investors allocate between 5 and 13% to real estate.
Figure 1 below shows that listed real estate has attractive total returns compared to other asset classes. Data from the United States is used, because it allows comparison between listed and unlisted real estate and other asset classes over longer horizons. Over this period, listed real estate outperforms both equities and unlisted real estate.
Figure 2 shows that over longer holding periods, correlation of real estate with equities decreases, while correlation with direct real estate increased over longer holding periods. This also proves the diversification benefits of listed real estate.
Based on these findings, Robeco real estate portfolio managers and analysts have built an optimal portfolio framework. They have used academic methods and simulation of historical returns to calculate the optimal mix of assets that gives the best risk-return combination. The model is applied to a range of interest rate environments. This framework demonstrates that a 5-10% allocation to listed real estate is optimal.
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