Having examined returns from investing in REIT stocks, it’s natural to ask about returns from direct ownership of real estate. In theory, direct ownership should provide higher returns than indirect ownership through REITS. That’s because REITS provide much greater liquidity to the investor, so presumably a lower return is required. The returns from direct ownership, however, are more difficult to assess than REIT returns since there is no day-to-day market valuation for the real estate holdings. The income from properties can be tracked by the investor, but changes in the values of these properties depend on appraisals unless the property is sold in that particular time period. The same problems arise in measuring returns on private equity investments (as discussed in the chapter on private equity).

Since the early 1980s, the National Council of Real Estate Investment Fiduciaries (NCREIF) has collected return data on real estate owned by institutional investors (the great majority of which are pension funds).9 The data are reported to NCREIF by the investors themselves or by institutional real estate investment managers. In 2004, there were 4,152 properties in the index with a total market value of $145 billion.10 The properties range from apartments and hotels to industrial properties, office buildings, and retail shop structures.

The NCREIF returns are reported quarterly with data beginning in 1978. The returns consist of two elements, net operating ...

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