CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

CHAPTER 19

Public versus Private Real Estate Risks

Aprimary challenge of real estate investment management is to assess the relative reliability of the conflicting indications of risk generated by observations of publicly traded real estate investments, such as REITs, and privately held real estate. Privately held real estate is typically highly illiquid, taking months or even years to trade at competitive prices. This illiquidity is driven by the extent to which each property is unique. The high illiquidity of most real estate can raise serious challenges for portfolio management, including cash management, risk measurement, and risk management. Public real estate is highly liquid, with readily observable market prices. But indices of public real estate prices indicate substantially higher volatility and substantially lower diversification benefits than do indices of private real estate.

This chapter focuses on the extent to which analysis of publicly traded real estate may be used to provide information on the risks and returns of private real estate. It begins with an empirical analysis of the differences between the returns of public (market-based) real estate and those of private (appraisal-based) real estate.

19.1 MARKET-BASED VERSUS APPRAISAL-BASED RETURNS

Chapter 16 provided an analysis of the differences between market-based and appraisal-based real estate returns over a five-year period that included the global financial crisis that began in 2007. The analysis of Chapter ...