Four Reasons to Blend REITs and Private Real Estate

Before assessing our four reasons, we provide some context into our approach. If an investor’s goal is to capture the long-term return of institutional real estate, the portfolio holdings should reflect the structure of the investable market. Although a portfolio that only owns private real estate may appear diversified within private benchmarks, it likely remains incomplete relative to the full real estate universe. For example, a portfolio may overweight certain property types and valuation mechanisms common in private funds, but underweight those that are primarily represented in the public market.

1. REITs Provide Access to Alternative Sectors

A strategic advantage of blending public and private real estate is sector access. Private core funds’ exposure remains concentrated in traditional core property sectors, i.e., industrial, residential, office, and retail. Those sectors represent a minority of the REIT universe. Instead, REITs primarily provide exposure to alternative real estate sectors, such as data centers, communication towers, and health care facilities (Exhibit 1).

Exhibit 1:

REITs provide greater exposure to alternative real estate sectors

Different property types are driven by varying economic variables. Among the traditional core sectors, industrial demand may be tied to trade flows and e-commerce, while residential demand depends on factors like affordability and local labor conditions. By adding alternative exposures, REITs can reduce reliance on any single set of sector fundamentals. For instance, data centers are linked to cloud adoption and AI workloads.

2. The Higher Return Dispersion in REITs Creates Arbitrage Opportunities

The high dispersion in REIT returns can be an advantage because it rewards accurate active management.

Arbitrage opportunities arise due to the variations across listed companies, including those pertaining to sector exposure, property quality, geographic footprint, and tenant mix. Market sentiment can also create large differences in pricing across sectors. A data center REIT, a tower company, a healthcare REIT, an apartment REIT, and a mall owner may all be classified as real estate, but their fundamental drivers and market valuations can differ significantly.

This dispersion creates opportunity for investors who can identify mispriced securities and favorable sector exposures. The same logic applies within sectors, as company-level selection may provide a powerful complement to private-market property or market selection.

3. Adding REITs to a Private Portfolio Enhances Risk-Adjusted Returns

Due to different volatility profiles, a model portfolio that combines private core real estate and REITs can lower volatility and increase returns when compared to a purely private or public real estate portfolio.

Rather than focusing on public vs. private exposure in isolation, investors may benefit from focusing on the blended outcome. The blend can enhance returns, reduce volatility, and improve the return per unit of risk. Therefore, the investment policy should evaluate public and private real estate jointly rather than separately.

Our model suggests that the return per unit of volatility peaks at an allocation of roughly 30% REITs and 70% private real estate, with annual rebalancing. This framework allows investors to benefit from both long-term convergence and short-term dislocation.¹

The 30% figure is also consistent with market size: If REITs represent nearly 30% of invested real estate, then a roughly equivalent allocation is consistent with the market weighting while also improving modeled, risk-adjusted returns.¹ This convergence between market representation and portfolio efficiency strengthens the strategic case for a blended approach.

Furthermore, blending public and private real estate can reduce the severity of annual drawdowns, given that each asset class often recognizes stress at different times (Exhibit 2).

Exhibit 2:

A blended portfolio can reduce the severity of annual drawdowns

Value dislocations in the short run create tactical opportunities. Since public trades can be executed more quickly, REITs are a useful sleeve for implementing tactical real estate views. While REIT returns often lead private commercial real estate in the near term, returns converge over longer investment horizons.

4. REITs Offer Improved Liquidity

Liquidity is another all-important strategic benefit of REIT exposure, which can generate cash for time-sensitive investment opportunities and support risk management through efficient adjustments to public positions. Liquidity can also help meet other cash needs without forcing private asset sales at unfavorable times.

A portfolio with a liquid real estate sleeve has more optionality than one that is entirely illiquid. This optionality can be especially important during periods of stress, when private redemption queues may lengthen and transaction markets may slow. Public-market liquidity may come with higher measured volatility, but it gives investors flexibility that private vehicles cannot consistently provide.

Conclusion

While strategic allocation ranges and tactical tilts may be appropriate, the baseline portfolio allocation should recognize REITs as a core component of the real estate market, not a peripheral or optional add-on. When nearly one-third of invested real estate is represented by REITs, excluding them requires a strong active view. In the absence of such a view, the more balanced approach is to incorporate REITs into a strategic real estate allocation.