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Diversification Benefits of Public Real Estate Securities in the Mixed Asset Portfolio

Diversification Benefits of Public Real Estate Securities in the Mixed Asset Portfolio

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Diversification Benefits of Public Real Estate Securities in the Mixed Asset Portfolio Kimberly R. Goodwin and Leonard V. Zumpano Contact Author: Kimberly R. Goodwin Email: [email protected] Department of Economics, Finance, and Legal Studies The University of Alabama P.O. Box 870224 Tuscaloosa, AL 35487-0224 Phone: 205-348-0255 Fax: 205-348-0590 Leonard V. Zumpano Email: [email protected] Department of Economics, Finance, and Legal Studies The University of Alabama P.O. Box 870224 Tuscaloosa, AL 35487-0224 Phone: 205-348-8988 Fax: 205-348-0590
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2 Abstract Despite a great deal of study, researchers have yet to agree on whether adding real estate securities to a mixed asset portfolio increases return and lowers risk. This paper seeks to make such a determination by using a unique measure of real estate returns. We also employ more current data that reflects recent institutional changes in the REIT market which have made these securities more popular and more widely traded. Using monthly public real estate returns for the period 1990 through 2005 we find that real estate securities do provide diversification benefits in the form of increased return and decreased risk when funds are re-allocated from stocks. Real estate securities also provide a positive return due to diversification. Does the addition of real estate securities improve the performance of a mixed asset portfolio? So far researchers have not been able to provide a definitive answer to this question. While past research concluded that public real estate securities add little benefit to a mixed asset portfolio, more recent findings suggest that researchers may have been too hasty in ruling out the benefits of real estate to the mixed asset portfolio. This study thus reexamines this issue and, in doing so, contributes to the literature in two significant ways. First, this study uses more recent data. This is particularly important considering the nature of the institutional changes to REITs in REIT market that have transpired during the 1990s. REITs became more popular and much more widely traded securities following the regulatory changes governing their ownership in 1993 1 . This effect was not fully captured in earlier studies. Second, this study contains a unique measure of real estate returns that more fully captures the performance of public real estate securities. Past studies have defined real estate using one of several appraisal-based indices or the 1 Both the Omnibus Budget Reconciliation Act of 1993, allowing each individual pension fund investor to count as an individual to fulfill the REIT ownership requirements, and the structural innovation of the umbrella partnership REIT (UPREIT) structure spurred enormous change in the REIT markets in the early 1990s.
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3 NAREIT index. Appraisal-based indices do not reflect actual market returns on securitized real estate and are thus not appropriate when studying the effect of adding real estate securities in a portfolio. The NAREIT index is based on market returns of REITS, but there are many real estate firms in the market that choose not to operate as a REIT.
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