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Aon Retirement and Investment Blog

Real Estate Beta: Understanding the Power of Core

Real estate is a unique asset class that may help produce more efficient portfolio outcomes when included in a multi-asset class portfolio. While the asset class broadly can play different roles in a portfolio depending on where a portfolio is on the risk/return spectrum, core real estate—which focuses on investing in stabilized (high occupancy) assets—provides the highest potential for improved efficiency in a multi-asset class portfolio. While this blog entry focuses on core real estate, non-core real estate investing, which invests in largely non-stabilized assets and other higher risk projects, may provide attractive opportunities at the higher end of this asset class risk/return spectrum for investors looking for that type of profile. 
Possible benefits of core real estate include increased diversification, significant income, attractive risk-adjusted returns, and the potential for inflation hedging. These benefits, along with core assets representing the largest share of the investable universe, are why core real estate is often referred to as the asset class beta. Aon Hewitt believes that real estate beta should be a staple long term component to most institutional asset allocations.
Thinking Beyond Stocks and Bonds
The real estate asset class enjoys qualities of both of the major liquid asset classes: fixed income and equities. Contractual payments by tenants stemming from leases create a consistent income stream akin to fixed income coupons, but the ability to reset leases upon expiration and add capital value to the hard asset creates a growth component that is more equity-like in nature. These hybrid characteristics generally put the risk/return profile of core real estate between fixed income and equities.
While having characteristics of both fixed income and equities, core real estate performance historically has generally had low correlations to the major public markets, and offered downside protection during many public market dislocations. These low correlations have been a function of a variety of factors, including stickier income streams due to the longer term contractual nature of leases, distinctive new supply cycles, private market ownership, and unique factors associated with the physical assets.
Core real estate’s low correlations, solid income returns, and ability to adjust rents and pass through expenses as economic conditions change are attractive further diversifying attributes to be added to a traditional asset class portfolio.
Portfolio Modeling Benefits
In short, incorporating core real estate in a multi-asset class portfolio may help investors achieve a similar total return with less volatility…or conversely, higher returns for the same level of expected volatility. The below exhibit demonstrates this point.
The exhibit, which was developed based on Aon Hewitt’s Q3 2015 ten-year forward-looking capital market assumptions, depicts two efficient frontiers that illustrate the expectations for portfolios with and without an allocation to core real estate. The efficient frontier that includes real estate provides efficiency improvements at every allocation level. 

  • The blue curve reflects portfolios that include return-seeking assets of only global equities and risk-reducing assets of only broad U.S. fixed income
  • The red curve depicts a portfolio that allocates 15% of the return-seeking assets to core real estate from global equities 

Past performance is no guarantee of future results. 
Is Now the Time to Make an Allocation?
Aon Hewitt Investment Consulting believes that core real estate should be a staple part of most institutional investment portfolios, which means holding long term over a full real estate cycle to gain the highest potential benefit from its inclusion. If your plan lacks exposure to core real estate, now may be a good time to start building an allocation. An allocation of between 5-15% of return-seeking assets is typically appropriate in order to drive total portfolio benefits.
Today Aon Hewitt’s capital market assumptions place long-term core real estate return expectations between broad fixed income and equities. The firm’s current medium-term views give a slight preference to core real estate reflecting a slow normalization of interest rates where income growth can still provide positive appreciation. While investors should not expect the same outsized market rebound performance that core real estate has delivered over the last five years, current market dynamics suggest that core real estate may deliver long-term average return and risk expectations over the medium term, and the prevailing environment is a reasonable entry point.**
For more details on core real estate, see our recent white paper “Real Estate Beta: Understanding the Power of Core.
*NCREIF (National Council of Real Estate Investment Fiduciaries) is a not-for-profit trade association that serves its membership, and the academic and investment community's need for improved commercial real estate data, performance measurement, investment analysis, information standards, education, and peer group interaction. NCREIF produces several real estate indices tracking performance of the asset class, with data going back to 1978.
**The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice. 

David Rose is an Associate Partner in Aon Hewitt’s Real Estate consulting practice based in Chicago, IL. 
Catherine Polleys is a Partner in Aon Hewitt’s Real Estate consulting practice based in Park City, UT.
Content prepared for U.S subscribers, but available to interested subscribers of other regions.

The information contained above should be regarded as general information only. That is, your personal objectives, needs or financial situation were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of acting on this information, particularly in the context of your own objectives, financial situation and needs.Nothing in this document should be treated as an authoritative statement of the law on any particular issue or specific case, nor should it be treated as investment advice. Use of, or reliance upon any information in this post is at your sole discretion. It should not be construed as legal or investment advice. Please consult with your independent professional for any such advice. The blog content is intended for professional investors only.

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