How Many Properties are really Needed for a Diversified Family Office Real Estate Portfolio?
Diversification is an important strategy for a family office to maintain their legacy and wealth for future generations. The results of this study, suggest that by just giving thought to including a wider range of locations and perhaps a broader mixture of property sectors will result in a significant reduction in the risk of a real estate portfolio while still having the focus on value add or even opportunistic opportunities.
It is important for family offices to include properties that you think are probably less correlated with each other -whether it is different property types, different locations, different occupancy levels, different dates when leases come up for renewal, etc. By considering the correlations, even if subjectively, as part of your thinking when building a real estate portfolio, your risks will be significantly decreased within your portfolio to maintain the family’s wealth.
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Supporting Data
To show this, we did an experiment using data from the National Council of Real Estate Investment Fiduciaries which has a database of about 10,000 properties around the US consisting of all the major property types (office, industrial, retail, apartment and hotel). We created portfolios of different sizes by drawing properties randomly from the NCREIF database and calculated the standard deviation over a specified time period.
Key Insights and Takeaways
It has been shown that 15 to 20 randomly selected stocks can eliminate most of what is referred to as “unsystematic” risk in a stock portfolio. Unsystematic risk is unique to a specific property which can be eliminated through diversification. What remains is the “systematic risk” that impacts all stocks and is measured by the well known “beta.” The question is whether a similar number of randomly selected real estate investments can also reduce most of the unsystematic risk. Properties are real as opposed to financial assets and are lumpier than stocks and each property is unique. Does that make it harder to diversify?
We considered the results for restricting the properties that are included in the portfolio to properties that were greater than 90% leased since these are usually considered less risky than those with lower occupancy. Interesting enough, risk is reduced more by including properties that are less than 95% occupied. In other words, even though individual properties that are greater than 95% occupancy are considered less risky, from a portfolio perspective, including a wider range of occupancy is better. Read full whitepaper for a detailed study and understanding.
