Maarten van der Spek: Why listed real estate is 'real' real estate

December 24, 2024

_{This column was originally written in Dutch. This is an English translation.}

By Maarten van der Spek, Spek Advisory & Adjunct Professor of Real Estate TIAS Business School

Listed real estate is often wrongly considered an equity class. By not including it in your property allocation, you create a sub-optimal property portfolio.

A common misconception is that listed real estate, such as publicly traded Real Estate Investment Trusts (REITs) or real estate companies, is simply another form of equity and therefore belongs in the equity portfolio. This belief stems from the short-term behaviour and tradability of listed real estate, whose value fluctuates widely due to market sentiment and economic developments. However, investors should focus on the fundamental characteristics of listed real estate, and these are mostly similar to those of private real estate.

Fundamental similarities and differences

The idea that listed real estate is substantially different from private real estate is fuelled by the way they are valued. REITs are publicly tradable, so their value is continuously adjusted to market developments and liquidity. Private real estate, on the other hand, is valued only periodically, resulting in a more stable but less up-to-date valuation profile. As a result, listed real estate is often seen as volatile and ‘share-like’, while private real estate is considered ‘bond-like’ because of its apparent stability.

Yet listed real estate companies manage physical properties just like private portfolios. Think office buildings, shopping centres or logistics centres. In the long term, their performance is mainly linked to the underlying property assets, as has also been proven by solid academic research[1]. Although the correlation between listed real estate and private real estate is low in the short term, it increases significantly for longer investment horizons, reaching a level of 0.7-0.8 for a horizon of two years or more.

The advantages of listed property within property allocation

Listed real estate offers some unique advantages for inclusion in real estate portfolios. Chief among these is liquidity: REIT shares can be traded easily on the stock exchange, unlike private real estate transactions that often take months. In addition, listed real estate gives access to global markets and various real estate sectors, allowing investors to easily diversify beyond their local markets. Moreover, REITs often provide access to niche markets, such as data centres or healthcare real estate, which are harder to enter through private investment.

Another advantage is transparency. Costs associated with REITs are well disclosed in the reports, while costs in private real estate are often hidden in external fees. The costs of public real estate are thus implicitly included in the returns, while those of private are often explicitly included in a fee. However, research shows that total costs between the two forms are often comparable.

A more optimal portfolio with listed property

For property investors with a long horizon, a combination of listed and private property is often optimal. Whereas listed property offers increased liquidity and a larger investment universe, private property provides a stable income stream and some stability in returns. Do realise that some of this is only on paper, due to the valuation basis. Together, they can form a balanced portfolio that optimises returns and manages risk under different market conditions. Moreover, additional returns can be generated by taking advantage of the differences in valuations.

The optimal relationship between listed and private real estate depends on the investor's goals and risk tolerance, but one thing is clear: the two forms actually complement each other very well. By combining the two, investors benefit from the best of both worlds: liquidity, diversification, and stability.

[1] See Hoesli, M., & Oikarinen, E. (2021). Does listed real estate behave like direct real estate? Updated and broader evidence. Applied Economics, 53(26), 3023-3042.