Swedroe: Real Estate Isn’t Special

April 30, 2018

The following table shows results from a portfolio allocating about 67% to SV and 33% to CORP. This optimal replicating portfolio has a monthly correlation with REITs of 0.72. The table also presents other data points that compare the optimal replicating portfolio to REITs over the period January 1978 through September 2016



The replicating portfolio dominates REITs in almost every way—it earns higher compound returns, has lower volatility, achieves a higher Sharpe ratio, has lower kurtosis and wins on most historical risk characteristics. A skeptic might note the replicating portfolio has a 33% allocation to long-term corporate bonds during a period in which interest rates have declined significantly. However, the regression results show the term factor loading for the replicating portfolio is lower than the term factor loading for REITs. Thus, interest rate risk exposure can’t account for the results.


The findings from the two papers I reviewed demonstrate that returns to real estate are well-explained by exposure to common, systematic factors. These factors—market beta, size, value, term and default—comprise an uncorrelated set with compensated return premiums. In contrast, idiosyncratic real estate sector risk and misappraisals contribute to risk but not return. In other words, investors using factor exposures to determine their portfolio allocation do not need to consider adding real estate as a separate asset class.

For investors using asset classes to determine their allocation, the findings suggest that REITs should receive no more than a market-cap weighting. Data from Morningstar show REITs represent approximately 3.5% of the iShares Russell 3000 ETF (IWV) on a market-capitalization basis, which is a valid starting point for a REIT allocation.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.


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