Making the case for listed real estate

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Investors who have been inclined to dismiss listed real estate as an attractive asset class since the financial crisis should perhaps reconsider. They are likely missing out on the important roles listed real estate can play in multi-asset portfolios: that it can operate as a proxy for direct real estate while generating diversified returns with a stronger income component arising from high dividends and while also protecting – perhaps surprising to some – against rising interest rates (see exhibit 1 below for an overview of annualised returns for listed real estate in different regions between 1990 and 2013).

These are some of the main conclusions drawn by the authors[1] of new research from BNPP IP and contained in a new white paper “The case for listed real estate in a multi-asset portfolio.

Exhibit 1 (1A): Decomposition of total annualised average returns into price returns and reinvested dividends for five regions: US, UK, Eurozone, Asia and developed countries. This graph shows the decomposition of returns for listed real estate in these regions based on the FTSE EPRA NAREIT indices.

Annualised returns (in local currencies) for Listed Real Estate 1990-2013

Annualised returns (in local currencies) for Listed Real Estate 1990-2013

The research shows that, over the long term, investment in listed real estate offers an exposure to direct real estate[2] while addressing the well-known illiquidity problems associated with owning a portfolio of buildings (see exhibit 2 below which gives an overview of transaction times for listed as opposed to direct real estate). The advantages in terms of liquidity are particularly important because of the potential to exploit, through active management, inefficiencies existing among countries, markets and sub-sectors.

Exhibit 2: Average number of days to liquidate 50%, 90% and 100% of a EUR 1 billion global portfolio of listed and direct real estate in similar market conditions as from October 2013 to February 2014, local currency, monthly data. Data source: Jones Lang LaSalle Inc. and FactSet.

Listed real estate exhibit 2

Robust optimisation techniques show that listed real estate should be considered within a multi-asset portfolio for diversification against uncertainty in return forecasts and variance-covariance forecasts. In the long-term, listed real estate tends to show low correlations with other asset classes (see exhibit 3 below) and can thus offer diversification benefits. The underlying real estate exposure that REITs[3] and REOCs[4] provide also provides diversification through the ownership of portfolios of multiple properties.

From a broader investment management perspective, portfolio managers can realise the potential benefits from adding listed real estate to a multi-asset portfolio to generate additional uncorrelated alpha from exploiting both top-down and bottom-up inefficiencies in the asset class. Listed real estate offers opportunities for active management not typically exploited in either equities or direct real estate.

Exhibit 3: Correlations between the global listed real estate total returns and the returns to other global asset classes over different investment horizons (different return frequencies) from 1990 to 2014, based on USD quarterly returns. Data source: GPR, Citi, MSCI.

Global asset class correlations

Global asset class correlations

The research also considers the question raised by many asset allocators of whether it is worth investing in real estate when long-term interest rates, at least in the important US market, look set to rise. The historical performance of the asset class reveals that, over the past 20 years, investors would have been unwise to ignore its ability to benefit from inflationary shocks in addition to its diversification and performance-enhancing advantages. Real estate can still produce attractive income as well as the prospects of growth in a changing rate environment.

The benefits of active management in listed real estate

Active management will become more important as markets adjust to rising bond yields as central banks like the US Federal Reserve continue to reduce monetary stimulus. Investors need to be able to manage the sector differences that can be similarly exploited. Despite recent strong performance our active managers are in a position to focus on specific real estate sectors, emphasise individual city or regional markets and exploit themes across regions and countries.

Real estate contributes to portfolio diversification in a number of ways. In the short-term, its relatively high correlation with risky asset classes like equities limits the diversification benefit from an ex-ante risk point of view but robust optimization techniques show that listed real estate should still be added to a multi-asset portfolio for diversification against uncertainty in return forecasts and variance-covariance forecasts. In the long-term, listed real estate tends to show low correlations with other asset classes and thus the benefit in terms of diversification is more naturally observed.

In addition, we should also not overlook the underlying real estate exposure that REITs3 and REOCs4, provide in terms of diversification through the ownership of portfolios of multiple properties, rather than investments in single properties.

From a broader investment management perspective, portfolio managers can recognize the potential benefits from adding listed real estate to a multi-asset portfolio. Managers have the potential to generate additional uncorrelated alpha from exploiting inefficiencies in the asset class both at top-down and bottom-up level as we shall see later. Listed real estate offers opportunities for active management which are not typically exploited in either equities or direct real estate.

If you would like to receive a copy of the full white paper please send an email to: publicationcentre@bnpparibas-ip.com

[1] Majdouline Zakaria, financial engineering team quantitative analyst and Raul Leote de Carvalho, deputy head of financial engineering, with Shaun Stevens, real estate strategist and Jan Willem Vis, chief investment officer of global listed real estate, all of BNP Paribas Asset Management, based Paris and Amsterdam

[2] Direct real estate includes real estate physical property investments and unlisted funds

[3] REITs distribute dividends directly to shareholders

[4] REOCs reinvest dividends in their business

Frédéric Surry

Deputy Head of Equity

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