IIJournals JPM-Special Real Estate Article Collection | Page 6

EXHIBIT 3
Evolution of the US Real Estate Investment
Opportunity Set (Estimated Breakdown of
Investable Universe by Capital Source)

Source: Hudson-Wilson et al. [2005], Cornerstone Research, Federal
Reserve Board Flow of Funds, ULI Emerging Trends in Real Estate,
DTZ.

The rise of public market real estate alternatives
has also created feedback mechanisms among the quadrants. For instance, the rising importance of REITs as an
investment vehicle coincides with their growing importance as owners of the underlying direct real estate.
Packer et al. [2013] examine the effect of the market
for REITs on the private commercial real estate market
and report that the presence of REITs in the market has
dampened the building cycle (which, in the past, typically followed a boom–bust process), likely due to public
market signals increasing the informational efficiency of
the private market.
Each of the four forms of real estate (and potentially different subtypes of assets within each quadrant)
has distinct investment characteristics and could easily
be placed within different asset buckets. The appropriate
role of each quadrant in a portfolio, as well as the relationship among the quadrants, are open questions. In
this issue, Ang et al. [2013] examine the relationship
between the public equity and private equity quadrants.
They find a common real estate factor underlying both,
but with short-run idiosyncratic deviations from trend
being driven by different factors in private and public
markets. The authors also show that much of the dif-

SPECIAL R EAL ESTATE ISSUE 2013

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ferential in performance between private and public real
estate, as ref lected in long-term average index returns
and volatility shown in Exhibit 2, is related to both differing property type compositions and financial leverage
in public REIT capital structures, and not public versus
private market pricing of the underlying real estate
assets.
Since the financial crisis, many investors have
looked more seriously at commercial real estate debt
strategies as a viable source of return. Hence, the Quadrant approach is becoming more widely accepted, and
the concept of real estate as a single homogeneous asset
class is increasingly being questioned, as more institutional investors recognize the potential benefits of the
f lexibility to invest across, and even in layers or tranches
within, the quadrants. This, of course, can allow for
more finely tuned portfolios that better meet the needs
of investors. However, when real estate can have different forms, which may fall within different asset classes,
it does create challenges for decisions about what should
be the appropriate “real estate allocation.”4
Finally, even when constraining oneself to the private equity real estate quadrant, allocation decisions continue to be clouded by the nature of the asset class and
data issues. As in Exhibit 2, real estate as an asset class
is often represented by an index such as the NCREIF
Property Index, based on unlevered (and mostly core)
assets. However, due to the uniqueness of individual
real estate assets, a direct real estate index such as this
is not investable. Given the lack of a developed derivatives market for real estate, the common indexes used to
represent real estate and make asset allocation decisions
are not accessible to investors. Newer indexes such as
NCREIF’s ODCE and the PREA | IPD U.S. Property
Fund Index are based on returns to open-end funds and
are therefore investable, and they represent advances in
the ability to properly benchmark real estate portfolios.
But even these do not match many institutional investor
portfolios, which often involve significant exposure to
closed-end value-add and opportunistic funds. For these
types of funds, fees—and the associated manager incentives—can have a much larger effect, and the industry’s understanding of risk–return parameters is much
more limited. Attempts to create benchmarks based on
closed-end funds are complicated and have thus far not
been universally accepted. Hence, investors’ real estate
portfolios can look very different from the benchmark

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