- RE four broad segments:
- Private debt: mezzanine commercial RE debt, mortgage REITs; Gilberto-Levy Commercial Mortgage Performance Index.
- Public debt: CMBS; Lehman CMBS / Aggregate indexes.
- Private equity: direct property holdings; appraisal-based, smoothed performance; NCREIF Property Index.
- Public equity: REITs, REOCs, listed RE companies; NAREIT Global RE Index.
- Feldman (2004), Pagliari (2005), and Frost (2005) studies conclude public and private RE (equities) long-term returns and volatilities are statistically indistinguishable and REITs may be used as a proxy for private RE. Private RE and REITs have increased correlations in recent periods, and over longer horizons, which should happen as the underlying investments are the same, and more private RE becomes securitized.
- Overlap between traditional market indexes and REITs: 100% of U.S. REITs and listed RE companies are in the Russell 3000. REITs comprise 1% market cap of S&P 500, 3% of Russell 1000, 10% of Russell 2000; 2% of MSCI EAFE.
- From 1990-2005, North American RE had the highest Sharpe Ratio of traditional asset classes, while European and Asian RE had the lowest Sharpes. North American RE benefitted from efficiency gains in transition to REITs; European RE hurt from late REIT adoption in the K.; Asian RE hurt from new adoption of REIT structure and high currency volatility in many countries.
- Global REITs have low to negative correlations with the traditional asset classes, particularly bonds and U.S. large cap stocks. North American REITs have relatively high correlation with small cap stocks (Russell 2000).
- Chopra and Ziemba (1993) estimate traditional mean-variance optimization is 11x more sensitive to estimation error than variance is, and variance is 2x more sensitive than covariance is.
- By including private RE (with traditional 6 asset classes), Hudson–Wilson, Fabozzi, and Gordon (2003) estimate global RE should represent 8.3% of the global market portfolio. However, with more non-traditional asset classes added to the market portfolio, the allocation to RE should reduce. Average U.S. pension plan RE allocation is only 4%.
- Using re-sampled (Monte-Carlo) forward-looking mean-variance optimization:
- Sharpe’s CAPM reverse-optimization market equilibrium returns:
- Conservative risk (5% volatility) portfolio: 70% bonds, 22% equities, 8% REITs.
- Moderate risk (10% volatility) portfolio: 40% bonds, 44% equities, 16% REITs.
- High risk (15% volatility) portfolio: 8% bonds, 70% equities, 22% REITs.
- Black-Litterman Bayesian optimization with CAPM historical returns:
- Conservative risk (5% volatility) portfolio: 71% bonds, 17% equities, 12% REITs.
- Moderate risk (10% volatility) portfolio: 40% bonds, 37% equities, 23% REITs.
- High risk (15% volatility) portfolio: 7% bonds, 58% equities, 35% REITs.
Finished: 1-Sep-08