Value‐weighting and the variability of real estate returns: Implications for portfolio construction and performance evaluation

Summary

Compared with most investment markets, real estate is illiquid and indivisible; each asset represents a discrete, unique and lumpy addition to a portfolio. Consequently, many funds have an unequal distribution of lot sizes. These characteristics have important implications for the ability to diversify risk and should properly be taken into account when applying portfolio theory to real estate. Drawing on previous work, this paper investigates the impact of value‐weigh ting on risk reduction. It shows that the perceived reduction in risk by having a large number of assets may be illusory if a portfolio has an uneven distribution of asset values. The coefficient of value skewness is proposed as a useful measure which summarizes the extent to which a portfolio is characterized by unequal lot sizes.

Keywords:

• Real estate
• risk
• diversification
• portfolio size
• value distribution