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For Optimal Real Estate Performance, Blend Public and Private Assets

A new report from J.P. Morgan Asset Management examines how different ratios of public to private real estate holdings affect returns and volatility.

A new report from J.P. Morgan Asset Management posits that investors would likely reach the most effective portfolio allocation to real estate by blending public REIT holdings with private assets in core sectors. The sweet spot offering the highest returns with more modest levels of volatility ranges between a 60% to 80% allocation to U.S. private core real estate and a 20% to 40% allocation to U.S. publicly-traded REITs, J.P. Morgan researchers found.

According to Jared Gross, head of institutional portfolios strategy with the firm, institutional investors have long benefited from using private real estate funds to access core real estate sectors. However, using public REITs to invest in a greater range of property sectors helps diversify exposure to real estate as an asset class and provides added flexibility and liquidity.

“Our findings suggest that a structural 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 and public real estate," Gross wrote in an email.

For example, J.P. Morgan researchers estimate that an 80/20 allocation weighted toward private core real estate should deliver a forward-looking compound 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 deliver an 8.1% return with 11.1% volatility.

Compound returns in the scenarios tested by the team rose as the ratio tilted more toward public REITs, reaching 8.2% for the 40/60 mix and staying at the same level through the 100% allocation to public REITs. However, so did volatility, which rose to 11.7% with a 50/50 mix and gradually reached 16% with a 100% allocation to public REITs.

The report’s authors noted this is because the volatility profile for public REITs matches that of other equities. That is, in part, why they recommend an allocation that incorporates private real estate investments, which feature volatility that is somewhere between that found in equities and fixed-income products.

“We believe that REITs should serve as a complement to private real estate, not as 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 appraisals tend to smooth out returns and may distort the true level of risk present in these investments. For example, looking at the period between 2009 and 2023, J.P. Morgan researchers found quarterly data indicated private core real estate assets experienced volatility of 7%. When annual data was considered instead, the volatility rose to 13%.

However, that figure was still below the volatility experienced by public REITs during the same period, which averaged 21% based on quarterly data and 17% based on annual data.

In addition, J.P. Morgan found investing in a global real estate portfolio, rather than limiting investments to the U.S., helped achieve higher returns since property sectors can perform differently based on local dynamics. For example, office buildings in Asia Pacific have had a much more robust post-pandemic recovery. As a result of that and similar trends, J.P. Morgan expects forward-looking compound returns averaging about 8.5% for global REITs compared to the 8.2% return expectation for U.S. REITs.

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