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Direct and Indirect Real Estate in a Mixed-asset Portfolio

Is direct or indirect preferable?

Written by Johan Falk

Paper category

Master Thesis


Architecture & Real Estate




Master thesis: 6.6 Indirect or direct real estate in a mixed asset portfolio? Pagliari et al. (2003) A study was conducted during 1981-2001 to try to investigate whether securitized real estate is better than direct real estate, and whether there is any difference in volatility. The characteristics of securitized real estate are the NAREIT index and direct real estate as the NCREIF index. Before 1993, the NAREIT index accounted for 15%-20% of the total market value of the real estate market (NAREIT + NCREIF). During the period 1992-2001, NAREIT accounted for an average of approximately 65% ​​of the total market share (NAREIT + NCREIF). Large institutional investors tend to invest directly in the real estate market, while smaller investors tend to support securitized (public) real estate. From 1981 to 2001, the average annual yield of securitized real estate investment was 13.47%, and the volatility was 14.66%. During the same period, the average rate of return of the direct investment real estate market was 8.43%, and the volatility was 5.91%. The return difference is 500 basis points and the volatility is 250 basis points, which is somewhat consistent with the results of Riddiough et al. (2005). It should be noted that these return and volatility series have been adjusted by removing non-core REITs, removing leverage, and removing evaluation smoothing, so the two different investment types are more comparable. Compared with the earlier data series, in recent years (1993-2001), the difference in return and volatility between the two different investment types has decreased. This means that improved market efficiency, increased market value, and better data availability all contribute to the real estate market, where securitized real estate and direct real estate show a longer-term synchronization. (Pagliari et al., 2003) Obviously, when considering making two different investment types more similar, there are still factors that can explain liquidity, governance, transparency, control, or administrative compensation. Since institutional investors tend to invest more in the direct real estate market, while smaller investors tend to invest more in the securitized real estate market, it can be seen that these two different types of investors obviously attach importance to these factors. The degree is different. 6.7 What are the risk factors associated with real estate investment? In order to calculate the level of risk (volatility) in a real estate portfolio, the general method is to use the returns from a real estate sample and use this to simulate portfolios of different sizes but with the same weight. Then calculate the average risk level of each investment portfolio. Early research has shown that when the size of the portfolio increases, the level of risk decreases, and all other things being equal, the strongest decline occurs in the top 20-40 assets (Byrne and Lee, 2001). After 40 properties, any increase in the size of the investment portfolio will result in a slight decrease in the level of risk. Therefore, managers who invest in mixed asset portfolios will believe that relatively few assets are needed to reduce unsystematic risks to almost zero. According to Byrne and Lee (2001), when estimating the level of risk in real estate, there is a problem with applying equal weights to simulate investment portfolios, but in fact they are usually value-weighted. On the other hand, due to factors affecting the uniqueness of real estate, value-weighted simulated real estate investment portfolios are likely to be impractical and cannot be obtained and used by practitioners. On the contrary, it is more inclined to use actual data from real estate portfolios of different sizes. 22 Byrne and Lee (2001) conducted an empirical study on actual data of real estate investment portfolios of different sizes. The regression results confirm the earlier research in this field that, on average, the risk of large portfolios is often lower than that of small portfolios. It is worth noting that there are still relatively many small-scale investment portfolios that can have high or low risks, which shows the uniqueness of real estate. Therefore, a portfolio managerin this thesis who invests with the goal of obtaining average risk is likely to get a risk that is much higher or lower than expected (in other words, the risk is calculated as an average value) because the actual risk varies greatly. Earlier studies have shown that based on equal weighted simulation portfolios of various sizes, 20-30 assets are sufficient to reduce unsystematic risks to almost zero. The results of Byrne and Lee (2001) based on actual real estate portfolios of various sizes indicate that this is a major understatement. The actual assets that need to be held to reduce unsystematic risks to almost zero are more likely to be in the range of 400-500 assets. Previous studies in the field of correlation of public stock markets around the world have pointed out that when comparing the stock markets of various countries, the correlation between the two is low, but when comparing the major stock markets, the correlation is significant. Read Less