A new report from JP Morgan Asset Management posits that investors are likely to achieve the most effective portfolio allocation in real estate by mixing public REIT holdings with private assets in key sectors. The sweet spot that offers the highest returns with the most modest levels of volatility ranges between a 60% to 80% allocation to US private real estate and a 20% to 40% allocation to traded REITs publicly in the US, JP Morgan researchers found.
According to Jared Gross, head of institutional portfolio strategy with the firm, institutional investors have long benefited from using private real estate funds to tap into prime real estate sectors. However, using public REITs to invest in a wider range of property sectors helps diversify exposure to real estate as an asset class and provides increased flexibility and liquidity.
“Our findings suggest that a structured position in REITs of up to one-third of the total real estate portfolio may be advisable for balancing returns and risk while capturing the full spectrum of sector diversity across private real estate and public,” Gross wrote in one. email.
For example, JP Morgan researchers estimate that an 80/20 allocation weighted towards private real estate should deliver a compounded return of 7.8% and come with 10.5% volatility. A 70/30 allocation should provide a 7.9% return with 10.7% volatility, and a 60/40 allocation should provide an 8.1% return with 11.1% volatility.
Component returns in the scenarios tested by the team increased as the ratio tilted more toward public REITs, reaching 8.2% for the 40/60 mix and remaining flat through the 100% allocation to public REITs. However, so did volatility, which increased to 11.7% with a 50/50 mix and gradually reached 16% with a 100% allocation to public REITs.
The report's authors noted that this is because the volatility profile for public REITs matches that of other stocks. This is, in part, why they recommend an allocation that includes private real estate investments, which exhibit volatility that is somewhere between that found in stocks and fixed income products.
“We believe that REITs should serve as a complement to private real estate, not a substitute for it,” they wrote.
The report's authors also recommended investors look at a calendar year of returns for private real estate funds to get an accurate picture of their performance. Quarterly estimates tend to smooth returns and may distort the true level of risk present in these investments. For example, looking at the period between 2009 and 2023, JP Morgan researchers found quarterly data that showed that major private real estate assets experienced volatility of 7%. When annual data was considered, volatility rose to 13%.
However, this figure was still below the volatility experienced by public REITs over the same period, which averaged 21% based on quarterly data and 17% based on annual data.
In addition, JP Morgan found that investing in a global real estate portfolio, rather than limiting investments in the US, helped achieve higher returns as property sectors can perform differently based on local dynamics. For example, office buildings in Asia Pacific have had a much stronger post-pandemic recovery. As a result of this and similar trends, JP Morgan expects forward-looking compounded returns to average around 8.5% for global REITs compared to an expected return of 8.2% for US REITs.