Why should defined contribution plans invest in real estate?
It is generally accepted among the investment and academic community that income-producing real estate is a fundamental asset class that potentially brings additional diversification benefits to long-term investment portfolios along with equities, bonds and other assets. This proposition is based on specific, well-documented attributes of real estate investment, including:
- A distinct economic cycle relative to equities and bonds due to supply inelasticity, which reduces the correlation of investment returns from real estate with the returns from other assets,
- Competitive, long-term investment returns that potentially provide high and growing income from rents plus moderate capital appreciation over time,
- Portfolio diversification benefits within equity and bond portfolios, and
- Potential inflation hedging attributes due in part to the fact many leases are tied to inflation and that real asset values tend to increase in response to rising replacement costs.
Modern portfolio theory also argues that well-diversified investment portfolios should include allocations to all assets in the market basket, including real estate, which is the third largest asset in the U.S. investment market basket after equities and bonds.
How should defined contribution plans offer real estate investment through REITs?
Defined benefit pension plans have invested in real estate, including stock exchange-listed REITs, for decades. While defined contribution programs such as 401(k), 403(b) and 457 plans, have been slower to include real estate, their adoption of the real estate asset class in recent years has been rapid. A significant portion of plans have added real estate investment options on a stand-alone basis. However, many more have incorporated the asset class within their asset allocation offerings, such as target-date funds.
Based on surveys conducted by investment consultants such as Callan Associates and management consulting firms such as Casey Quirk, a vast majority of target-date funds used by defined contribution plans now feature a real estate allocation. While a limited number of target-date funds invest in real estate through “direct” or “private” investment vehicles in addition to listed REITs, most of these asset allocation products provide real estate exposure exclusively through investments in stock exchange-listed equity REITs because of their daily market pricing, low cost, liquidity and long-term record of performance.
Research on the role of REITs in investment portfolios including target-date funds
In an effort to serve the defined contribution community, Nareit-sponsored research with investment consulting firm, Wilshire Associates, on the role of REITs and listed real estate equities in target date fund asset allocations. Using data from 1975 through 2013, this study found that a meaningful allocation to U.S. or global listed REITs increased the long-term investment performance and diversification benefits of target date portfolios. An allocation of between 5% to 18% was found to be potentially optimal for investors saving for future retirement.
- Wilshire Associates Study: The Role of REITs and Listed Real Estate Equities in Target Date Fund Asset Allocations
- Target-Date Funds With Meaningful REIT Exposure
- 10 Fastest Growing Target-Date Funds with Meaningful REIT Exposure
Need REIT industry information or research data?
Nareit serves the institutional investor community as a resource on the role listed REITs and real estate companies can play in investment portfolios. Many plan sponsors, investment consultants and investment managers rely on data from Nareit’s internal research team and independent research partners for industry information and analysis to assist them in their use of listed real estate.
Should you be interested in obtaining information to assist you in considering listed REITs and real estate companies for your 401(k), 403(b) or 457 defined contribution plan, please click here to email a member of Nareit’s Investment Affairs & Investor Education team.