What is the Optimal Allocation Level to Real Estate in a Swedish Mixed-Asset Portfolio Including both Direct and Indirect Real Estate?

Abstract: We use mean-variance analysis to examine the optimal allocation to real estate for institutional investors investing in Swedish assets and whether direct real estate provides diversification benefits to a mixed-asset portfolio. The study takes the perspective of institutional investors interested in dividing the real estate asset class into the two asset categories direct real estate and indirect real estate. We compute a hedonic house price index as a representation of the direct real estate asset based on Swedish residential transactions in metropolitan areas. The indirect index is the real estate sectoral index designed by NASDAQ OMX Stockholm. We include ten different stock industry specializations when computing optimal portfolios. The study finds that the average optimal allocation level to real estate of all ten portfolios is 25.56%. The portfolio with highest Sharpe ratio is found when the investor invests in technology stocks, at an optimal allocation to real estate of 2.92%. In all portfolios, except when the investor specializes in technology, we find that direct real estate provides diversification benefits in the long run. Diversification benefits are also found to be more significant during financial crises.