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How Much Should you Allocate to Real Estate?

In our post on 5 Reasons Why Real Estate Should be Part of Your Investment Portfolio, we highlighted some of the key reasons why real estate is a must-have in your portfolio. However, there is little guidance on how much real estate should be incorporated into one’s portfolio.

The Institutional Allocation

To answer this, let’s take a look at the allocation institutions make in real estate. Lazard in its report entitled, The Impact of a Real Estate Allocation in a Diversified Portfolio, found that institutions like Harvard and Yale had allocations of 10% and 20% respectively in real estate. Institutional Real Estate Inc. found in its 2013 Annual Plan Sponsor Survey that the average allocation to real estate ranged from 7% to 10%. A study by Cornell University and Hodes Weill & Associates (2013) surveys allocations of 198 institutional investors worldwide and finds an average allocation to real estate of 8.8%, which is below their average declared target allocation of 9.8%. In MSCI’s paper entitled, Asset Owner Survey 2013 – Real Estate Implications, MSCI found that asset owners held on average 35% of their investments in alternatives in real estate. The 138 asset owners surveyed, held an average of 6.7% of total assets in real estate. This figure was also probably understated as leverage would have increased exposure and many asset owners did not include REITs or commercial mortgage-backed securities (CMBS) within real estate.

The Academic Allocation

A Norges Bank’s report on The Diversification Potential of Real Estate found that based on academic research on the benefits of adding real estate to a portfolio, the median suggested allocation was 15% over 30 reviewed studies, with the median ranging from 6% to 21%. Overall, most of the literature concluded that the addition of real estate to a mixed-asset portfolio was beneficial, and recommended allocations ranging from 10% to 20%.

How Much Real Estate?

The above mentioned ranges of portfolio allocation give a guidance on the general allocations made by institutions and individuals in real estate.

To determine your optimal level of real estate exposure, you need to understand their tolerance for risk. Risk tolerance differs between investors, and investors should consult with a knowledgeable real estate investment advisor to find out what works best for them.

     

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