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A risk-return comparison.
(ProQuest Information and Learning: ... denotes formula omitted.)
Over the 24-year period ended in 2001, returns on publicly traded real estate investment trusts (as proxied by the National Association of Real Estate Investment Trusts or NAREIT Index) averaged 14.7%, while private real estate returns (as proxied by the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index or NPI) have averaged just 9.7%. This 500 basis point performance difference prompts the question as to whether this differential is attributable to some underlying structural reason (e.g., optimal contracting issues, the efficiency of public markets) or whether it is happenstance. In short, does the platform matter?
The answer to this question has important portfolio management implications. If one form of the legal entity used to hold the assets clearly and persistently offers superior risk-adjusted returns, this vehicle ought to become the dominant real estate investment vehicle over time, all else equal. If there is no clearly superior vehicle, the two platforms can be viewed either as substitutes or as point in a continuum of risk-adjusted return alternatives.
Circumstantially, the persistence of REITs' excess performance is corroborated by their growing popularity (see Exhibit 1). The market (debt and equity) capitalization of REITs has exceeded that of the NPI since the mid-1990s. While REITs accounted for only 15%-20% of the total market capitalization for the two indexes prior to 1993, they have averaged an approximate 65% market share since 1992.
The dramatic change in market share is a function of the tremendous growth in REIT market capitalization beginning in the early 1990s. That said, both indexes have experienced tremendous gains in total capitalization. Together the two started 1982 with a little over $4 billion and ended 2001 with nearly $400 billion (a growth rate exceeding 25% per year).
A different story emerges when we confine the analysis to defined-benefit pension plans. These institutional investors clearly have the opportunity to invest in either the public or private real estate platform. Yet the majority of large pension funds choose to allocate the bulk of their real estate equity capital to private market vehicles.
The top 25 pension funds with an allocation to private real estate equities represent, in the aggregate, an approximate $80 billion commitment.1 The...