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PORTFOLIO DIVERSIFICATION
THROUGH REITS
A Look At The Ibbotson Analysis
2008
The Ibbotson analysis addresses
the investment benefits of publicly
traded equity REITs only; all data
contained in the analysis are
derived from, and apply only to,
publicly traded securities.

National Association of Real Estate Investment Trusts®

REITs: Building Dividends and Diversification®
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R
eal estate investment trusts (REITs) make it
possible for anyone to invest in large-scale,
income-producing commercial real estate. REITs are
companies focused primarily on owning, and most
often operating, investment-grade real estate.
Investors purchase shares of a REIT in the same
manner in which they acquire shares of other
publicly traded companies.

In addition to current income and growth over

time, REITs provide investors with a strong source
of portfolio diversification. In its widely recognized
2008
analysis on REITs’ role in multi-asset portfolios,
Ibbotson Associates established the diversification
benefits from investing in REITs. From conservative
fixed-income investors seeking to raise their
incomes and lower their portfolio’s risk to stock
and bond investors seeking to diversify away from
a concentrated portfolio, REITs offer an attractive
way to answer an age-old investment question:
“How can I increase my return without taking on
more overall risk?”

This pamphlet provides an overview of the

Ibbotson analysis and its important findings.
Results of the Ibbotson analysis are contained in a
PowerPoint presentation that includes a basic
review of the REIT industry, the investment
characteristics of real estate stocks and the asset
allocation analysis and conclusions. The presenta-
tion is available from Ibbotson Associates at its
Web site, www.ibbotson.com.

For more information on the REIT and publicly

traded real estate industry, visit www.nareit.com.
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Ibbotson Associates, a leading authority on asset allocation, examined the

historical performance of REIT equity securities to determine if real estate
stocks provide meaningful benefits in diversified portfolios.

Starting with the rationale for investing in Consistent long-term performance

Compound annual total returns, 1972-2006
diversified portfolios, Ibbotson points to
basic tenets of modern portfolio theory,
Bonds 8.7%
which state that each investment should
display return attributes that are Large Stocks 11.4%

sufficiently different from those of other

Int’l Stocks 11.8%
investments, and each investment should
offer competitive returns over time. The Equity REITs 14.0%

correlation of investment returns is

Small Stocks 14.9%
important in choosing investments that
are appropriate for a well-diversified
portfolio, since diversifying across such
Ibbotson documented that REIT returns have been
investments should minimize overall port-
competitive with those of other types of investments
folio risk for all levels of portfolio return. over long investment horizons.

Declining Equity REIT correlation

60-month rolling periods

Correlation
• vs. Small stocks
• vs. Large Stocks Since 1992, the correlation of
• vs. Bonds
equity REIT returns with the
0.55
returns of other stocks and
0.40
bonds has remained relatively
0.08
low. Specifically, Ibbotson
documented low to moderate
correlation of returns from REITs
Begin 1972 1977 1982 1987 1992 1997 2000
with returns from small-cap
End 1976 1981 1986 1991 1996 2001 2006

stocks, suggesting that small

stocks are not substitutes for
Correlation measures the extent to which
returns from different investments move together the diversification benefits of
over time. Low to moderate correlation is sufficient REITs.
to provide portfolio diversification benefits.
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The Ibbotson analysis uses a widely recognized mean-variance, asset allocation

process to demonstrate that REITs can raise the return and lower the risk of a
wide range of multi-asset portfolios. For example, REITs can add significant
diversification benefits to today’s 401(k) plans, which often include no real estate
investment choices.

Efficient portfolios without REITs

Constrained optimization 1972 - 2006

Ibbotson constructed various portfolios with and without REIT allocations.

Whenever allocations to REITs were available, the asset allocation model
chose the maximum allowable allocation to REIT stocks to build the most
efficient portfolios, which provide the highest possible rates of return at any
given level of risk.

Efficient portfolios including REITs

Constrained optimization (20% REITs) 1972 - 2006

Investors may
improve their
portfolio
returns with
an allocation
to REITs.

REITs improved returns at

each level of portfolio risk.
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Ibbotson expanded its analysis to include additional asset classes not previously
considered, including small- and mid-cap stocks, emerging market stocks, high-
yield bonds and investment-grade corporate bonds. In all cases, REITs were included
in the most efficient portfolios of highest returns and lowest risk, suggesting that
these other asset classes are not effective substitutes for the diversification power
that REITs can provide.

Efficient frontiers with and without REITs

Stocks, bonds, T-bills, and REITs 1988-2006

Across the
• Portolfios with REITs
20 • Portfolios without REITs Emerging spectrum of
market stocks
REITs portfolio risk
15 Mid/small stocks
and return,
Large stocks
REITs are used
Gov’t bonds
10 International stocks
to build the
Corporate High yield
bonds bonds highest yielding

5 Treasury bills
portfolios.

0% Risk 5 10 15 20 25 30 35

REITs raise the efficient frontier of

multi-asset portfolios, thereby earning
a place in the intelligent investor’s
diversified portfolio.
Potential to reduce risk and increase return
Stock and bond investors, 1972-2006
• Stocks
• Bonds
• Treasury bills
• REITs
To demonstrate the benefits of 10% 10%
20%
investing in REITs, Ibbotson 10%
40%
50%
created sample portfolios with 45% 10%
40%
various levels of allocations to 35%
30%
REITs.
Return: 10.7% Return: 11.1% Return: 11.5%
Risk: 10.9% Risk: 10.6% Risk: 10.5%
Sharpe ratio: 0.42 Sharpe ratio: 0.48 Sharpe ratio: 0.52

As seen in this set of portfolios,

investing 10 percent or 20 percent
in REITs both increased the
portfolio’s total return and lowered
the portfolio’s overall risk.
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Ibbotson’s analysis highlighted two fundamental aspects of REIT returns: substantial

current income and moderate, long-term price appreciation that protects investors
against inflation over long investment horizons.

Over the last 20 years, approxi- Reliable income returns

mately 7.7 percentage points of Equity REIT annual returns, past 20 years
40%
the 14.3 percent average annual
• Price return
30
total return of the FTSE NAREIT • Income return
• Average annual
income return
Equity REIT Index came from 20

dividends, producing a high level 10

of reliable income through all 0

market conditions. Over the long -10

term, more than 50 percent of

-20

REIT total returns have come

-30
from dividend income. 1997
1987 1992 2002

Besides income, the balance of

Equity REIT price index versus CPI REIT total returns comes from
1981-2006
long-term price appreciation of the

$500
REIT shares that an investor owns.
Over the last 25 years, REIT share
400
• FTSE NAREIT Equity REIT Price Index prices have more than kept pace
• Consumer Price Index
300
with the Consumer Price Index
(CPI), a common measure of changes
200
in the cost of living, thereby
100 protecting an investor’s capital from
the corrosive effects of inflation.
0
1981 1986 1991 1996 2001 2006

Ibbotson Concluded:
• REITs offer an attractive risk/reward trade off
• Correlations of REIT returns with other investments have declined since 1992
• REITs may boost return and/or reduce risk when added to a diversified portfolio
• REITs are worth investigating as an addition to many types of diversified portfolios
• Small stocks and other asset classes are not substitutes for the diversification
power and income provided by REITs
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Investing in REITs
Here’s what Here’s what
Experts are Experts are
SAYING: DOING:
“REITs offer important return and diversification Pension Plans
potential and are important in stand-alone Survey data reported by The Pension Real Estate
target date funds. In addition, given that most Association (PREA) indicates investment in commercial
participants’ other taxable wealth is in the real estate by pension plans has been on the increase
form of stocks and bonds—assets that don’t since 2000. Illustrative of this is CalPERS, the largest
typically do well when inflation rises—having pension plan in the U.S., that increased its real estate
more inflation sensitive assets within their allocation from 8% to 10% in late December 2007. In
target date funds is a very important diversifier,” all, an estimated 70% of public sector pension plans
– Seth Ruthen, CFA, Executive Vice President, PIMCO, and 40% of corporate sector pension plans have
Real Estate Portfolio, January/February 2008. invested in real estate.

“REITs allow even the smallest investors to Endowments

own diversified portfolios of hundreds of David Swensen, Yale University’s Chief Investment
properties, spread across the country or the Officer, who is responsible for more than $22.5
world.” billion in endowment assets and other investment funds,
– James Glassman, Senior Fellow, American Enterprise and has accumulated one of the best investment
Institute,“Bargains in Real Estate Stocks,” Kiplinger’s Personal
performances among endowments in the last two
Finance, October 2007.
decades, says the “starting point” for a “well-diversified,
equity-oriented portfolio [that] provides a framework
“We believe almost all investors should own
for investment success” includes a target of 20% in real
REITs and listed real estate stocks .... For
estate assets, such as REITs, of the total portfolio weight.
investors without appropriate direct real estate
– David Swensen, Chief Invesment Officer, Yale University
asset allocations [which are most investors], a Endowment, “Unconventional Success: A Fundamental Approach to
separate asset allocation to commercial real Personal Investment” and The New York Times, Feb. 17, 2008
estate implemented with exposure to REITs
and listed real estate stocks worldwide seems 401(k) and Other Defined Contribution Plans
to be the best alternative.” The most important investment-related trend in the
– Thomas M. Idzorek, Michael Barad, and Stephen L. Meier, 401(k) industry is the dramatic increase in the use of
Ibbotson Associates and Morningstar, asset allocation products, such as target-date funds. In
“Global Commercial Real Estate: A Strategic Asset fact, data from a 2007 Plan Sponsor magazine survey
Allocation Study,” Journal of Portfolio Management
revealed that the proportion of plans offering target
Special Real Estate Issue, September 2007.
date funds jumped from 46.5 percent in 2006 to 87.5
percent in 2007. Some industry experts expect that a
“Real estate is not an alternative to stocks and
majority of assets in 401(k) plans will be invested in
bonds—it is a fundamental asset class that
these types of funds within the next few years. Another
should be included within every diversified
2007 survey in Plan Sponsor found that "...of 24 firms
portfolio. Equity, fixed income, cash, and real
offering target-risk and particularly, target-date funds,
estate … are the basic asset classes that must
14, or 58 percent, currently included a dedicated
be held within a diversified portfolio.”
allocation to real estate.”
– Robert M. Doroghazi, The Physician’s Guide to Investing:
A Practical Approach to Building Wealth.
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Data Sources: Small Stocks—Ibbotson Small Stock Series, represented by the fifth capitalization quintile of stocks on the NYSE for
1926-1981 and the performance of the Dimensional Fund Advisors, Inc. (DFA) U.S. Micro Cap Portfolio thereafter; Large Stocks—
Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general;
Government Bonds—Ibbotson 20-year U.S. Government Bond Index; REITs—FTSE NAREIT® Equity REIT Total Return Index;
International Stocks—Morgan Stanley Capital International (MSCI®) Europe, Australasia, and Far East (EAFE®) Index; Treasury
Bills—30-day U.S. Treasury Bill; DJ Wilshire 4500; Russell 2000; Russell 2000 Value; Inflation—Consumer Price Index, U.S.
Department of Labor; REIT Stock Price Appreciation—FTSE NAREIT Equity REIT Price Index; Mid/Small Stocks—Russell 2500;
Emerging Market Stocks—MSCI Emerging Markets Index; High Yield Bonds—Lehman Brothers High-Yield Index; Corporate
Bonds—Citigroup Long-Term, High-Grade Corporate Bond Index.

NAREIT® does not intend this publication to be a solicitation related to any particular company, nor does it intend to provide
investment, legal or tax advice. Investors should consult with their own investment, legal or tax advisers regarding the appropriateness
of investing in any of the securities or investment strategies discussed in this publication. Nothing herein should be construed to be an
endorsement by NAREIT of any specific company or products or as an offer to sell or a solicitation to buy any security or other
financial instrument or to participate in any trading strategy. NAREIT expressly disclaims any liability for the accuracy, timeliness or
completeness of data in this publication. Unless otherwise indicated, all data are derived from, and apply only to, publicly traded
securities. All values are unaudited and subject to revision. Any investment returns or performance data (past, hypothetical, or
otherwise) are not necessarily indicative of future returns or performance. © Copyright 2008 National Association of Real Estate
Investment Trusts®. NAREIT is the exclusive registered trademark of the National Association of Real Estate Investment Trusts.

All Slides (unless noted): Copyright ©2008 Ibbotson Associates, Inc.

National Association of Real Estate Investment Trusts®

REITs: Building Dividends and Diversification®
1875 I Street, NW, Suite 600 • Washington, DC 20006-5413
202-739-9400, Fax 202-739-9401 • www.nareit.com