Abstracts for Vol. 1, No. 1 of the Journal of Real Estate Portfolio Management

The Historical Environment of Real Estate Returns

Emily J. Norman, G. Stacy Sirmans and John D. Benjamin

Returns on real estate investments have been examined from many historical perspectives. This study provides a comprehensive review of the real estate investment literature according to the following topics: (1) general returns and risk on real estate, relative to other investments; (2) benefits from diversification and portfolio optimization; (3) returns on real estate as measured by REIT performance; and (4) inflation and real estate returns.

The results are quite interesting. Most studies that provide a comparison show that real estate has higher absolute returns than debt (such as bonds). The performance of real estate, in comparison to common stocks, is mixed. Slightly more than half of the studies that provide a direct comparison show a higher average return for stocks than for real estate. However, when adjusting for risk, most studies find that real estate investments have a higher return per unit of risk than bonds or stocks. There is a consensus among studies examining the issue that diversification with real estate can enhance risk-adjusted portfolio yield. Findings are mixed, however, on the returns of REITs, relative to other assets, and the inflation-hedging benefits of real estate.

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Real Estate Allocation in Pension Fund Portfolios

Vickie L. Bajtelsmit and Elaine M. Worzala

This study analyzes the actual role of real estate in pension plan investment portfolios by examining 1991 asset allocations for 159 pension plans. First, a review of recent theoretical research on real estate in a mixed-asset portfolio is presented. Analysis of the data indicates that allocations to equity real estate vary widely by plan, ranging from a 0%-17% of total plan assets, with a standard deviation of 4.22. Examination of the data shows that average allocations do not vary substantially by size and type of fund. For example, corporate allocations to equity real estate average 4.48%, whereas union and government funds, on average, allocate 3.78% and 5.05% respectively. The largest plans in the sample, those with more than $5 billion in assets, allocated only slightly less to equity real estate than did those with less than $1 billion in assets (3.96% compared to 4.02%). For other real estate-related asset classes, mortgages and mortgage securities, allocations exhibited greater variation by size and type of fund.

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Property-Type Diversification in Real Estate Portfolios: A Size and Return Perspective

Glenn R. Mueller and Steven P. Laposa

From the time that institutions began to invest in real estate, different property types have come in and out of investor favor. Unfortunately, pension funds have had little guidance thus far in how much of each property type they should hold, or even what ranges they should consider. Many investment advisors specialize in one or two property types, while other core advisors deal with all types of properties. In addition, most of the advisors seek and present as many attractive opportunities to institutional investors as they can find and most institutions have multiple advisors. As a result, institutional investors must make the property-type allocation decision at the portfolio level with conflicting advice from their advisors. This study reviews past property-type diversification information and presents some suggestions for answering the property-type diversification question. The total size of the real estate market basket, in square footage and value, is considered, as well as historical and projected returns for weightings on an efficient frontier. While property type should not be the only diversification strategy used, this study finds that property type allocations may enhance investor returns over real estate market and/or economic cycles.

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Improved Risk Estimation Using Appraisal-Smoothed Real Estate Returns

Graeme Newell and John MacFarlane

The use of appraisal-based real estate returns cause real estate risk to be underestimated. This study presents improved risk formulae to adjust for appraisal-smoothing in a quarterly real estate return series. Using the Russell-NCREIF real estate series for the 1980-93 period, we find that the standard risk estimates need to be almost doubled in order to obtain more appropriate real estate risk estimates for use by institutional investors and portfolio managers in mixed-asset portfolio decisionmaking. However, after accounting for reappraisal seasonality, the necessary risk adjustment is found to be an increase of approximately 80% (not quite double).

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Why the Efficient Frontier for Real Estate is "Fuzzy"

Richard B. Gold

By moving asset allocation models from the classroom to the boardroom, institutional real estate investors are confronted with a number of practical problems. Many of these difficulties are directly related to both data quality and availability and have received much attention in the current literature. While important, these concerns are perhaps overshadowed by the impact of uncertainty on the allocation process. In this study, uncertainty is introduced by boot-strapping expected returns and standard deviations in a traditional Markowitz framework. The results show that the efficient frontier is not singular, but "fuzzy". That is, this study illustrates that numerous statistically dissimilar weighted portfolios can be equally attractive for any given combination of expected risk and return and that allocation ranges rather than specific targets are, more realistic.

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Applying MPT to Institutional Real Estate Portfolios: The Good, the Bad and the Uncertain

Joseph L. Pagliari, Jr., James R. Webb and Joseph J. Del Casino

This study examines the application of a modern portfolio theory (MPT)-based portfolio strategy to institutional real estate investment. Specifically, a real estate investment strategy based on property-type allocation (with a broadly diversified geographic mix), in keeping with the prevalent practices of institutional investors, is analyzed. While MPT yields optimal ex post portfolios, its use as an ex ante portfolio allocation strategy, however, can lead to mixed results. Two five-year ex ante subperiods are analyzed. During the first of these two subperiods, the MPT-based portfolio strategies underperformed a naive and an average-mix (representing the aggregate property-type weighting of institutional investors during the previous subperiod) strategy. In the subsequent subperiod, the MPT-based strategy outperformed both the naive and average-mix strategies. However, in neither of the subperiods did the ex ante MPT-based portfolio strategies generate portfolios on the ex post mean-variance efficient frontier, nor did the average-mix portfolio outperform the naive portfolio. Finally, the consistency of the risk dimension (but not the return dimension) of the ex ante MPT portfolios suggests stability in the covariance matrix which may be useful for mitigating ex ante risk.

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