Schroders: Listed vs. unlisted real estate

Blending direct and indirect real estate exposure could improve returns

The position of real estate in an investor’s portfolio has long been debated. Whether the asset class should be included at all is rarely questioned, but the issue of which structure to use to build the allocation is less clear-cut. Indeed, having scrutinised a number of academic papers written on this issue, it appears that few investors have the optimal allocation to real estate. 

Over the last five, ten or fifteen years, an allocation to listed real estate has been demonstrated to provide increased returns relative to an unlisted real estate allocation. However, investors must weigh the increased returns against increased volatility when compared to an unlisted investment. In our view, the optimal allocation to real estate comprises a ‘blended’ portfolio.

Higher real estate demand is leading to greater scrutiny of real estate allocation

Structural changes to the pension fund industry – with the move from defined benefit (DB) to defined contribution (DC) – as well as other long term factors such as demographics, are leading many investors to question whether they have the optimal asset allocation to serve their needs in the future. We believe that these factors will also lead to increasing allocations to the real estate sector, as investors appreciate both its income and capital growth potential. The question now, is how best to achieve this real estate exposure.

While unlisted real estate funds have been the favoured option in the past, there is growing evidence that a purely unlisted real estate allocation is no longer the most efficient use of capital. For many investors, existing unlisted allocations can often be characterised by:

• A lack of sufficient diversification, with too many assets in one region, country or sub sector.
• Illiquidity in the portfolio, as a result of investing only in unlisted real estate funds or owning assets directly.

As investors analyse their existing real estate allocation and think about the future, we believe that liquidity will be a key consideration. What is the benefit of reduced volatility if you cannot redeem funds when required?

A number of investors now combine a less volatile unlisted real estate fund (or direct ownership) with more volatile listed real estate exposure. Both practical and academic evidence demonstrates that this gives investors the optimal blend of risk and return benefits. 

It is important to point out that the difference in volatility between unlisted real estate funds and the listed real estate sector is less significant, over the long term, than one might expect. Research shows that both types of exposure to real estate will provide investors with similar returns over a more extended timeframe.

Over the short-term there may be a difference in pricing between the two markets. This is due to the listed market pricing assets looking forward, using evidence as the market announces new information, such as leasing or investment transactions. In comparison, unlisted real estate funds will value assets (normally) every six months or perhaps annually and valuers will largely rely on historical evidence. The critical and common theme is that both markets are pricing the same assets. Therefore, the same direction will be followed, whether prices are increasing or decreasing and investors over the long-term should experience the same returns.

Der vollständige Beitrag im pdf-Dokument