Institutional investors should allocate more cash to real estate, investment bank Morgan Stanley has advocated.
“Real estate is an empirically attractive asset class. It consistently offers high current and total returns, and provides substantial diversification in a multi-asset portfolio,” argued Christian Schulte Eistrop, a vice president in Morgan Stanley’s investment banking division, in a report titled ‘The case for real estate’.
Schulte Eistrop said institutional investors would benefit substantially from real estate’s “attractive return profile, risk/return balance, portfolio
diversification and inflation hedging characteristics”.
He pointed out that academic research and industry studies suggest a real estate allocation of at least 10-15%, while a report from Altis Investment Management claims increasing the weighting of global real estate in a portfolio towards 20% moves it further towards maximum risk-efficiency. However, the average real estate allocation of institutional investors in the six largest European economies is 6.6% of total assets.
The steady and high income return generated by real estate gave it a major advantage over equities and bonds, said Eistrop. Over the longer term (and including periods of high inflation) government bonds produced a higher yields. However, the income return from government bonds has declined over recent years (see graph below).
Real estate also acted as a portfolio diversifier, argued Eistrop, as it had a historically low correlation with other asset classes, particularly equities (see table above). It was also a partial hedge against inflation, especially for investors in public or private real estate vehicles.
Morgan Stanley believes current developments
in the real estate market will aid institutional investors. A move from owner-occupation to investor ownership in Europe will free stock,
while the increasing scope of the unlisted funds
sector will offer investors more transparency and access to stock and professional management
more in line with other asset classes.
“As real estate investment increases with anticipated capital inflows and becomes more sophisticated in terms of diversification and professional management, it is ready to assume a more important role in the multi-asset class investment universe,” said Eistrop.
He also drew attention to some specific drawbacks of real estate: illiquidity, exposure to interest rate movements (for leveraged investors) and tenant default risk, but said these could all be
l In its latest Global Horizons report, UK
insurer Standard Life said it expected equities
to outperform most other asset classes over the next 20 years, but nonetheless an increased
weighting in real estate from 12-20%, could
be justified.