The Case Against REITS

Are Real Estate Stocks Attractive for Diversification?

November 2019. Reading Time: 10 Minutes. Author: Nicolas Rabener.


  • Real estate stocks featured moderate correlations to stock markets over the last 30 years
  • However, diversification benefits for equity portfolios were only marginal
  • Other strategies provide similar yield and downside protection characteristics


Surveys often reveal investor behaviour that is challenging to understand. For example, Preqin’s Alternative Investor Outlook for H2 2019 highlighted the following:

  1. 65% of institutional investors believe that real estate is overvalued and a correction likely to occur in 2019, 2020, or beyond.
  2. However, 45% want to allocate the same amount of capital to real estate and 28% even more.

It seems somewhat irrational that more than the majority of investors plan to allocate the same or more capital to an asset class that they believe is about to head into a correction. However, perhaps these survey responses simply reflect that investors are cautious about their own abilities to time market cycles correctly, which is a rational assumption given the difficulty of forecasting asset prices.

Determining the current point in the real estate cycle is as difficult as for any other asset class. Broadly speaking, the real estate cycle mirrors the economic one as rents and real estate values increase when GDP grows, and decline when the economy falters.

However, frequently the real estate cycle decouples from the economic cycle for various reasons, for example, a residential building boom created government subsidies, which makes the asset class attractive from a diversification perspective. This as well as the income and notion of owning a real asset explain why real estate is the second most popular alternative asset class for institutional investors with a 10.2% target allocation, after private equity.

Capital allocators can invest in real estate directly or indirectly via real estate stocks. Buying buildings directly or investing in real estate private equity funds incurs due diligence and management expenses, high transaction costs, multi-year periods of locking up capital, and a lack of transparency on current asset values given lagged valuations. In contrast, real estate stocks offer daily liquidi