It may be intuitive, but NAREIT, the US organisation for REITS, has concluded that the best risk-adjusted real estate portfolio is a mixture between publicly traded property companies and private equity real estate funds.
Following a recent study of two decades worth of performance data, NAREIT said the best mix of optimising risk and return is for a portfolio to have one third exposure to publicly traded REITs and two thirds to private equity real estate funds as opposed to 100 percent of either.
The organisation used the findings to point out that endowments and foundations that have traditionally allocated the majority of their real estate portfolio to private equity funds have since begun increasing allocations to REITs.
NAREIT president and chief executive officer, Steven Wechsler, said: “Given the risk reduction benefits and performance advantages of combining publicly-traded REITs and private real estate investments, it appears that pension funds could realise important advantages by reassessing their traditional reliance on private equity and other direct real estate investment.”
Joseph Harvey, president and chief Investment officer of Cohen & Steers, the real estate investment management firm, added: “At a point in time when many pension funds are actively seeking ways to reduce their risk and generate a higher level of continuing income to fund their liabilities, increasing allocations to REITs can provide real benefits. In recent years, endowments and foundations, who have historically allocated the majority of their real estate portfolio to private equity funds, have begun increasing allocations in their real estate portfolios to REITs in order to add liquidity and enhance returns.”
The study concludes a one third, two thirds mix offered the best risk-adjusted returns “based on the fact that the return cycles for REITs and direct real estate investment are different, providing diversification for the overall blended portfolio”.
The study also found that undiversified real estate portfolios comprised totally of core funds, commonly perceived of as the safest real estate investments and to which pension funds have dramatically increased their allocations over the past year, were actually significantly riskier than optimally blended public, private real estate portfolios.
For example, a blended real estate portfolio, it said, allocated to 50 percent to core funds, 30 percent to REITs and 20 percent to opportunity funds delivered 10 to 20 percent average annual returns in nearly two thirds of cases for rolling 5-year holding periods over the past 22 years.
In 40 percent of cases it produced single digit annual returns and never produced a 5-year period of negative returns – even during 2008, 2009 and 2010 when commercial property values plummeted.
By comparison, a portfolio of core real estate funds alone produced 10 to 20 percent average annual returns in only 40 percent of rolling 5-year holding periods and losses in more than 20 percent of 5-year holding periods.