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In an earlier post I reported research suggesting that optimized real estate allocations—for institutional investors that have access to private equity real estate funds—typically should have something like one-third invested in core funds, one-third in opportunistic funds, and one-third in publicly traded REITs. That analysis used data from 1992 through the first quarter of this year, which was the most recent available for value-added and opportunistic fund returns.

Since then, data for the second quarter have been released, so I revisited the research. It shouldn’t come as a surprise that the conclusions changed hardly at all.

One of the examples I used was an investor looking to achieve average net returns of 7.5% per year. The newest data suggests that investor’s optimized real estate portfolio should have been invested 58.2% in core funds, 25.1% in publicly traded equity REITs, and 16.7% in opportunistic funds.

Another example was an investor who is restricted from investing more than 30% in REITs—a fairly common constraint among pension funds. In that case, the optimized portfolio would also have had 36.3% in core funds and 33.7% in opportunistic funds, and it would have generated 8.28% per year in average net returns.

In fact, that’s remarkably close to the real estate portfolio that would have maximized risk-adjusted returns (the Sharpe ratio), which would have been invested 36.8% in core funds, 33.3% in opportunistic funds, and 29.9% in REITs and would have generated net returns averaging about 8.27% per year.

As I noted before, you can do this portfolio optimization yourself if you have the software. The average net returns were 2.91% per quarter for publicly traded equity REITs, 1.37% for core funds, 1.18% for value-added funds (which explains why they don’t show up in any optimized portfolio!), and 2.08% for opportunistic funds, and the covariance matrix was:

0.010834

0.0006074

0.000931

0.002082

0.000607

0.001135

0.001436

0.001703

0.000931

0.0014364

0.002218

0.002556

0.002082

0.0017026

0.002556

0.003851

Disclosure: Author is long ING Real Estate Fund and Vanguard REIT Index Fund

Disclaimer: The opinions expressed in this post are my own and do not necessarily reflect those of the National Association of Real Estate Investment Trusts ((NAREIT)). Neither I nor NAREIT are acting as an investment advisor, investment fiduciary, broker, dealer or other market participant, nor is any offer or solicitation to buy or sell any security investment being made. This information is solely educational in nature and not intended to serve as the primary basis for any investment decision.

Source: Revisiting the Optimal Institutional Real Estate Allocation