| Abstract: |
Many papers have recently pointed out that institutional investors allocate
only a very small fraction of their portfolio to real estate, much smaller
than theory would dictate. This raises the question, Are institutional
investors underinvested in real estate equities? Or do we simply have the
wrong priors? This paper is an attempt to provide some new insights into
this asset allocation paradox. The key conclusions of the paper are several:
First, unlike other assets, it would appear that real estate, and real estate
diversification, pays off at the very time when the benefits are most needed,
i.e., when consumption growth opportunities are low. Second, real estate
returns appears to be about the same as in stock returns. Third, real estate
performs well in an asset-liability framework. Fourth, the chance of
experiencing a large loss on real estate over a long horizon is quite small.
We also report here that private sector commercial real estate investments
represent between 6 to 12% of investable wealth in the U.S. Thus, it follows (if
one believes the CAPM) that if institutional investors were to invest more
in real estate (up to 12% of their assets), they should be able to eliminate
nonmarket or unique risk. All of this leaves us a bit dumbfounded as to
why institutional investors hold only between 2 to 3 1/2% of their assets in
real estate.
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