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, that is, when consumption growth opportunities are low. Second, real estate returns are predictable. In fact, the amount of predictability in 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 and 12 percent of investable wealth in the United States. Thus, it follows (if one believes the capital asset pricing model) that if institutional investors were to invest more in real estate (up to 12 percent 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 and 3 percent of their assets in real estate.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
References
Bergstresser, D., and J. Poterba. (2000). \ldDo After Tax Returns Affect Mutual Fund Inflows,\rd NBER Working Paper 7595, Cambridge, MA.
Black, F. (1980). \ldThe Tax Consequences of Long-Run Pension Policy,\rd Financial Analysts Journal July/August, 21–28.
Campbell, J. Y., and L. M. Viceira. (1999). \ldConsumption and Portfolio Decisions when Expected Returns are Time Varying,\rd Quarterly Journal of Economics 114, 433–495.
Chun, G. H., B. A. Ciochetti, and J. D. Shilling. (2000). \ldPension Plan Real Estate Investment in an Asset/Liability Framework,\rd Real Estate Economics.
Cho, H., Y. Kawaguchi, and J. D. Shilling. (2002). \ldUnsmoothing Commercial Property Returns: A Revision to Fisher-Geltner-Webb's Unsmoothing Methodology,\rd Journal of Real Estate Finance and Economics.
Cochrane, J. (1999). \ldPortfolio Advice for a Multifactor World,\rd NBER Working Paper 7170, Cambridge, MA.
Constantinides, G. M. (1986). \ldCapital Markets Equilibrium with Transaction Costs,\rd Journal of Political Economy 94, 842–862.
Craft, T. (2001). The Role of Public and Private Real Estate in an Institutional Investor's Portfolio, University of Wisconsion Ph.D. Dissertation.
Dammon, R., C. Spatt, and H. Zhang. (2000). \ldOptimal Asset Location and Allocation with Taxable and Tax-Deferred Investing,\rd Carnegie Mellon University\3-Graduate School of Industrial Administration Working Paper.
Del Guercio, D. (1996). \ldThe Distorting Effect of the Prudent-Man Laws on Institutional Equity Investments,\rd Journal of Financial Economics 40, 31–62.
Dickson, J., and J. Shoven. (1995). \ldTaxation and Funds: An Investor Perspective.\rd In J. Poterba (ed.), Tax Policy and the Economy, Vol. 9. Cambridge, MA: MIT Press.
Ennis, R. M., and P. Burik. (1991). \ldThe Influence of Non-Risk Factors on Real Estate Holdings of Pension Funds,\rd Financial Analysts Journal 44–55.
Fisher, J. D., D. M. Geltner, and R. B. Webb. (1994). \ldValue Indices of Commercial Real Estate: A Comparison of Index Construction Methods,\rd Journal of Real Estate Finance and Economics 9, 137–164.
Geltner, D. M. (1993). \ldEstimating Market Values from Appraised Values Without Assuming an Efficient Market,\rd Journal of Real Estate Research 8, 325–345.
Grossman, S. T., and G. Laroque. (1987). \ldAsset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumer Goods,\rd Econometrica.
Hansen, L. P., and R. Jagannathan. (1991). \ldImplications of Security Market Data for Models of Dynamic Economies,\rd Journal of Political Economy 99, 225–261.
Huang, J. (2001). \ldTaxable or Tax-Deferred Account? Portfolio Decisions with Multiple Investment Goals,\rd MIT Sloan School of Management Working Paper.
Kandel, S., and R. F. Stambaugh. (1990). \ldExpectations and Volatility of Consumption and Asset Returns,\rd Review of Financial Studies 3(2), 207–232.
Kritzman, M. P., and D. Rich. (2002). \ldThe Mismeasurement of Risk,\rd Financial Analysts Journal 58, 91–99.
Lintner, J. (1965). \ldThe Valuation of Risky Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets,\rd Review of Economics and Statistics 47(1), 13–37.
Malpezzi, S., and J. D. Shilling. (2000). \ldInstitutional Investors Tilt Their Real Estate Holdings Toward Quality, Too,\rd Journal of Real Estate Finance and Economics.
Malpezzi, S., J. D. Shilling, and Y. Y. Yang. (2000). \ldThe Stock of Private Real Estate Capital in U.S. Metropolitan Areas: Measurement and Determinants,\rd Journal of Real Estate Research.
Markowitz, H. M. (1959). Portfolio Selection. New York City: John Wiley and Sons.
Mehra, R., and E. C. Prescott. (1985). \ldThe Equity Premium: A Puzzle,\rd Journal of Monetary Economics 15, 145–161.
Merton, R. (1969). \ldLifetime Portfolio Selection Under Uncertainty: The Continuous Time Case,\rd Review of Economics and Statistics 51, 247–257.
Mossin, J. (1966). \ldEquilibrium in a Capital Asset Market,\rd Econometrica 34(4), 768–783.
Poterba, J., J. Shoven, and C. Sialm. (2001). \ldAsset Location for Retirement Savers.\rd In W. Gale and J. Shoven (eds.), Recent Advances in Corporate Finance. Homewood, IL.
Ross, S. A., and R. Zisler. (1991). \ldRisk and Return in Real Estate,\rd Journal of Real Estate Finance and Economics 4, 175–190.
Sa-Aadu, J., J. D. Shilling, and A. Tiwari. (2001). \ldThe Persistence and Timing of Portfolio Diversification Gains across Different Asset Classes,\rd University of Iowa Working Paper.
Samuelson, P. A. (1969). \ldLifetime Portfolio Selection by Dynamic Stochastic Programming,\rd Review of Economics and Statistics 51, 239–246.
Sharpe, W. F. (1964). \ldCapital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk,\rd Journal of Finance 19(3), 425–442.
Shoven, J. (1999). \ldThe Location and Allocation of Assets in Pension and Conventional Savings Accounts,\rd NBER Working Paper 7007, Cambridge, MA.
Shoven, J., and C. Sialm. (1998). \ldLong Run Asset Allocation for Retirement Saving,\rd Journal of Private Portfolio Management 1(2), 13–36.
Shoven, J., and C. Sialm. (1999). \ldAsset Location in Tax-Deferred and Conventional Savings Accounts,\rd NBER Working Paper 7192, Cambridge, MA, 1999.
Tepper, I. (1981). \ldTaxation and Corporate Pension Policy,\rd Journal of Finance 36, 1–13.
Author information
Authors and Affiliations
Rights and permissions
About this article
Cite this article
Chun, G.H., Sa-Aadu, J. & Shilling, J.D. The Role of Real Estate in an Institutional Investor's Portfolio Revisited. The Journal of Real Estate Finance and Economics 29, 295–320 (2004). https://doi.org/10.1023/B:REAL.0000036675.46796.21
Issue Date:
DOI: https://doi.org/10.1023/B:REAL.0000036675.46796.21