Diversification is a broad state which all investors rightly aspire to across the asset classes, including real estate. However, the simplicity of the concept belies the complications of achieving it: for example, how many assets does an investor actually need to buy to be diversified? The answer does not only determine the size of private real estate portfolios, but also the more fundamental decision of how to invest in private real estate. This could range from smaller amounts of capital for a stake in a fund-of-funds to a sizable equity commitment for a separate account.
This research paper seeks to answer the question for the optimum number of assets. We are not the first to attempt to quantify this but we have approached the question from a number of new practical angles. We look across several countries, and we study whether the answer varies across crisis or recovery phases. We also explore the difference if portfolios are dominated by a few large assets, and look at the situation for an investor who is risk-averse and wants to reduce the maximum risk it could face. We conclude by providing estimates of dollar amounts for portfolios to give sufficient diversification.
Building a portfolio reduces the aggregate return volatility, but incremental diversification benefits decline with every additional asset. Our research shows that if an investor wants to achieve a 90% reduction of the possible risk reduction, then it should look to invest in 11-18 assets, depending on the region. For an 85% reduction, this number is 8-11 while a 95% reduction would require 21-35 assets. If portfolios consist of assets of rather different sizes, more properties will be needed to reach the same reduction of specific risk.
Source : CBRE Global Investors