How the Real Estate Portfolio Optimizer Results are Calculated
The Real Estate Portfolio Optimizer is a tool to compare the returns and volatilities of institutional real estate portfolios composed of different combinations of publicly traded equity REITs and private real estate investment funds with core, value-added or opportunistic strategies. The optimizer calculates the actual return and volatility of a hypothetical portfolio on the basis of reported average returns for each type of real estate investment.
REIT.com Video: The Case for a Diversified Real Estate Portfolio
NAREIT economist Brad Case discusses the portfolio optimizer and the reasons for blending public and private real estate in institutional portfolios.
Determining an Optimum Portfolio
There are 176,851 possible combinations of portfolio allocations to REIT, core, value-added, and opportunistic investments in which each allocation (in percentage terms) takes on an integer value. Of these, 642 portfolios were optimal in the sense that no other portfolio provided higher average net returns while producing lower portfolio volatility; all others were sub-optimal in the sense that there existed at least one different combination of portfolio allocations that would have produced higher average returns with the same or lower volatility, or lower volatility with the same or higher returns.
The Data Behind the Optimizer
REIT returns are measured by the FTSE NAREIT Equity REIT Index, which represents a passively constructed free-float weighted portfolio of publicly traded U.S. equity REITs, but the optimizer assumes that the investor pays fees and expenses averaging 50 basis points per year (typical for an actively managed domestic REIT mandate).
Core private real estate investment fund returns, net of fees and expenses, are measured by the Open-End Diversified Core Equity (ODCE) Index computed by the National Council of Real Estate Investment Fiduciaries (NCREIF), which represents average returns to actively managed core real estate funds in which NCREIF members, primarily pension funds, invest. Value-added and opportunistic fund returns, net of fees and expenses, are measured by the NCREIF/Townsend Fund Indices, which represent average returns to actively managed value-added and opportunistic funds in which NCREIF data-contributing members invest.
Returns Based on 18 Years of Performance Reporting
The optimizer results are calculated based on quarterly returns from the first quarter of 1992 through the second quarter of 2010, the most recent quarter for which data on value-added and opportunistic funds are available. The earliest data available for all four assets is 1988Q4, but industry conversations suggest that data for the first few years of the NCREIF/Townsend Fund Indices may not be representative. If earlier start dates are used the optimal portfolios tend to have larger allocations to core funds and REITs, while, if later start dates are used, the optimal portfolios tend to have larger allocations to opportunistic funds.
The optimizer is based only on historically realized returns as reported by the respective data sources. The optimizer is not based on projections or forecasts of any kind, nor on de-smoothing of smoothed private real estate returns. Past returns and performance are not necessarily indicative of future returns and performance, and the optimizer is not intended to provide investment advice. It may be useful in evaluating the quality of investment advice on which investors relied to determine portfolio allocations during the historical period.