Refining Economic Diversification Strategies for Real Estate Portfolios

Abstract

Diversification of real estate portfolios has historically been accomplished by utilizing a geographic and/or property-type strategy. More recently, a number of economically based diversification categories have been proposed by industry researchers (see Hartzell, Shulman and Wurtzebach, 1987 and Wurtzebach, 1988). This study tests the efficiency of the existing geographic and geographic/economic strategies currently in the literature against an economically based diversification strategy using straightforward government SIC code categories. The three strategies used include: the NCREIF four geographic regions; the Solomon Brothers eight regions (a combination of economics and geography); and a purely economic grouping of the 316 MSAs in the United States using the nine major government SIC code categories.This study finds that the addition of economic underpinnings to a geographically constrained model, as developed by Hartzell et al. (1987) creates a higher risk/return efficient frontier than the purely geographic NCREIF diversification model. However, shedding geography altogether and diversifying along purely economic lines provides an even better efficient frontier during real estate cycle recovery and growth periods. This new strategy provides the real estate portfolio manager with the opportunity to increase risk-adjusted returns with a strategy that is easily understood and applied.

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