Commercial equity real estate: A framework for analysis
Christopher B. Philips, CFA, Vanguard Investment Counseling & Research, 08/17/2007Executive summary. The U.S. commercial real estate market has been estimated to be as large as $5.3 trillion.1 Historically, commercial real estate has provided competitive real returns and diversification opportunities for traditional portfolios. Yet an important question remains: Can an investment in commercial real estate actually deliver the characteristics and benefits of the broad real estate market? Indeed, investment vehicles such as real estate investment trusts or even limited partnerships or private investment pools can look quite different than the broad real estate market. The complexity of this question is a possible reason why institutional investors on average allocate only 2.5% to 4% of their portfolios to commercial equity real estate (Greenwich Associates, 2006, and Pension Real Estate Association, 2005). In fact, in contrast to
the $5.3 trillion investable market, as of December 2006 private real estate holdings were estimated at $310 billion (Chin, Topintzi, and Hobbs, 2007) and public REITs at $400 billion. This analysis evaluates the commercial real estate market and offers perspective regarding the various investment options. We contend that:
• Commercial real estate represents a unique and significant asset class.
• A real estate investment trust index serves as a long-term proxy for the commercial real estate market.
• Since REITs represent exposure to the commercial real estate asset class, a specific allocation to REITs may be based on a portfolio’s mandated objective; expected returns, risks, and covariance to the portfolio; or a unique circumstance.
• Because REITs are part of a broad-based U.S. equity portfolio, when determining an appropriate allocation to REITs, investors must factor in the exposure already contained within the active and indexed portions of the portfolio.
This entry has been added to Asset Class Reader: REITS