Portfolio Design: A Modern Approach to Asset Allocation

DIVERSIFYING INTO REAL ESTATE—ALTERNATIVES FOR ORDINARY INVESTORS

In 2005 David Swensen, the director of the Yale Endowment since 1985, published a book on investment designed for the ordinary investor. The book, entitled Unconventional Success: A Fundamental Approach to personal Investment presented a model portfolio for investors not wealthy enough (or perhaps too risk averse) to invest in exotic alternative investments. Swensen recommended that such investors consider two somewhat unconventional investments, real estate and Treasury inflation-protected bonds.

Let’s consider the diversifying power of real estate first. As Chapter 11 explained, there are many ways to invest in real estate. Most investors own a residence, but here we are discussing investable real estate including apartment buildings, office buildings, retail office space, and factory buildings. Many wealthy investors own such real estate directly rather than through funds. For these investors, the common feature of their real estate holdings is their lack of diversification. The real estate is typically in a single area of the country and often in the same type of real estate. For example, an investor may own apartment buildings or office buildings in the Los Angeles area, but not elsewhere in the country. Or an investor may own rental real estate in a vacation area, but little else.

As explained in Chapter 11, REITS offer diversification to an investor, both geographic diversification and diversification in the ...