Listed Real Estate – The asset class for the Millennial investor
Listed real estate has come of age as a significant asset class in its own right. Its size and diversity have expanded considerably over the last 15 years, although many investors have yet to accept this. Despite the worldwide growth in real estate investment trust (REIT) regimes and research on the potential benefits, many still favour investing in real estate directly or in non-listed investment vehicles.
Our research shows investors can improve the risk/return profile of balanced portfolios by allocating to global listed real estate. We believe one of the more thought-provoking findings is that listed real estate’s liquidity characteristics – real estate stocks can be bought and sold easily – have allowed investors to continue investing in real estate despite the recent financial market volatility.
Listed real estate as a portfolio diversifier
The search for the highest possible portfolio returns has intensified in recent years as expected returns on risk-free assets have plunged. Real estate has come more sharply into focus as portfolio strategists recognise its attractive income and overall returns.
Against this backdrop, we have assessed whether listed real estate can improve the risk and return characteristics of a multi-asset portfolio, using a robust optimisation technique.
Our research shows that including listed real estate in an allocation can improve returns dramatically without increasing volatility. Exhibit 1 shows the optimal listed real estate weight is almost 9%, improving the Sharpe ratio by a significant 14%.
Should REITs be included in institutional real estate portfolios?
One of the most persistent investor criticisms of listed real estate is that over the short term, these stocks behave like other equities and are just as volatile, while direct property markets and stock markets are uncorrelated, making the direct sector a portfolio diversifier, while listed real estate is not.
On the whole, academic research into the relationship between the performance of listed and direct real estate investment suggests that the returns from both asset classes are comparable in the long run. We agree. Listed real estate companies manage properties and collect rents and their capital expenditure and development costs are similar to those of unlisted real estate companies. The value of listed real estate companies is affected by the same changes in property markets and values over the long term.
Central banks induce regime shifts
So far so good, but markets underestimate risks
SUMMARY: US equities continued to outperform other markets such as EMU and EM equities. This partly reflects the divergence between the US economy -which is supported by fiscal expansion and a patient Federal Reserve- and relatively weaker growth in the eurozone and EM. But there is more to this divergence than faster US economic growth. The US equity rally has been led by the IT sector. This has accounted for 20%-50% of US equity returns since 2016. The rally is now looking stretched on various metrics. The other salient development in August was renewed stress in emerging markets (EM). A combination of economic stress in Turkey, weaker growth in China, Sino-US trade tensions and a stronger US dollar hurt EM assets. We believe there is value in EM assets, but the obvious circuit-breakers are still absent: a weaker USD, aggressive China stimulus and fresh Sino-US trade talks. EM assets prospects have soured and protectionism and tighter liquidity continue to cloud their longer-term prospects.