The Allocation of Real Estate to Future Mixed-Asset Institutional Portfolios

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Abstract
This paper uses the mean-variance framework to investigate real estate's role in an institutional portfolio. Unlike previous research, however, the paper does not assume a value for future real estate returns. Instead, it is assumed that real estate is held in the portfolio, and the level of expected return that is needed to justify the allocation is determined. Gross returns in the 10%-12% range appear to be sufficient; however, such returns are considerably greater than the sector's recent performance. The impact of adding real estate to a benchmark portfolio is reexamined using the shortfall risk approach. Finally, several caveats about using the mean-variance technique with real estate are described.