Real Estate in a Mixed-Asset Portfolio: The Role of the Investment Horizon



In this article, three oft-mentioned special characteristics of the real estate asset market—high transaction costs, marketing period risk and return predictability—are addressed in analyzing the role of U.K. commercial real estate investments in a mixed-asset portfolio. Due to favorable horizon effects in risk and return, the allocation to real estate in a portfolio with stocks, bonds and cash increases strongly with the investment horizon. Examining the relative importance of return predictability, transaction costs and marketing period risk for the optimal allocation to real estate, the article finds that the consideration of return predictability is very important, except for short-term horizons. Accounting for transaction costs is crucial for short- and medium-term investors. Marketing period risk appears to be negligible. Traditional mean-variance analysis—that is, ignoring return predictability, transaction costs and marketing period risk—can be very misleading.