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Cross-Asset Real Estate Portfolios Outperform

03,2005
Randy Fuchs

Previous studies have proven that real estate enhances overall performance in typical stock and bond portfolios, by increasing returns while lowering overall volatility or risk. To date, investors have achieved real estate diversification primarily through a single real estate asset class such as REIT investments or private real estate equity holdings.

Investing in various types of real estate assets offer various risks, returns and betas. For instance, Common REIT shares returned 13.4% with 12.7% volatility over ten years, while Private Real Estate produced 10.3% returns but only 1.7% volatility (unadjusted NAREIT estimates). Correlations between such sub-classes are low, thereby offering opportunities to combine them into a portfolio that increases the diversification benefits for investors.

Boxwood was commissioned to examine quantitatively the risks and advantages of establishing a cross-real estate asset fund compared to other options for obtaining real estate exposure. Several findings of Boxwood's study, which encompassed Common and Preferred REITs, CMBS and Private Real Estate Equity, include:

  • Overall Stock and Bond Portfolios Perform Better with Real Estate Exposure. Boxwood's study confirmed results of earlier academic and financial research that portfolio risk can be substantially reduced with real estate investments. In today's financial environment, investors with typical investment portfolios can reduce risk by 200 basis points through additions of real estate. Alternatively, investors can boost overall portfolio returns an annualized 1.3% without assuming any more risk.
  • Real Estate Investment Portfolios that Diversify across Sub-classes Perform Even Better. Boxwood's results showed that in today's environment, careful construction of Common REIT, Preferred REIT, CMBS, and Private Real Estate Equity can reduce volatility by over 500 basis points compared to portfolios with 100% REIT allocations-the most common real estate investment for retail investors. More notable is the clear superiority of all portfolios that contain private investment allocations. Portfolios with private real estate uniformly hit the return targets with substantially lower risk. It became evident that Common REIT shares are harnessed to increase return while risk is controlled by private real estate equity.
  • Multi-Asset Real Estate Portfolios Outperform Single-Asset Portfolios over a 10-Year Period. Based on the study's earlier findings on the merits of diversifying within real estate asset classes, Boxwood illustrated the advantages flowing to a multi-real estate asset allocation approach with a backtest over ten years ending in late 2004. The “Modeled Multi-Asset Portfolio”, which quantitatively determines the composition and changes in portfolio allocations periodically over time, convincingly outperformed various single-asset portfolios. For instance, the Modeled Portfolio returned 12.9% annually, beating the return of the private real estate portfolio by 200 basis points with equivalent volatility (3.6%). Also, the Modeled Portfolio handily outperformed Preferred REIT investments and, while the Portfolio's returns were modestly less than that of a 100% Common REIT portfolio, the former had only about 1/4 of the REIT portfolio's volatility.