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Diversified core real estate funds often set target allocations for each property type. However, dramatic changes in property type values can cause portfolio holdings to deviate sharply from target levels. Rebalancing a portfolio’s holdings can be challenging. Given high transaction costs, liquidity and typical holding periods, it can be hard to quickly reallocate toward targets.

We demonstrated this by showing how a portfolio with an equal weighting (25%) of multifamily, industrial, office, and retail (neighborhood, community and strip centers) would change in each quarter from Q3 1996 through Q2 2035. We applied CBRE EA’s value index for each sector in all the potential investment periods during this timeframe (there are 12,090 of them) to show how much the portfolio allocation deviated from the target allocation.

Figure 1 shows the periods’ highest and lowest deviations from the equal-weighted target for each sector and when they occurred. The biggest deviation was in the industrial sector from 2014 to 2026. During this time, the sector has seen incredible growth and strong fundamentals, often attracting capital at the expense of office, which saw its performance prospects wane even before COVID. Retail, which has perennially been below target in most portfolios, is expected to exceed target allocations based on CBRE EA’s capital value forecasts.

Because of the high transaction costs and illiquidity associated with physical real estate, a long-short REIT portfolio could be a viable option for maintaining capital allocations close to target. An investment fund could, for example, short industrial REITs and use the proceeds to buy office REITs until it is able to sell and buy enough assets to rebalance its property portfolio. Of course, this analysis simplifies away from cash. Another option is to use excess cashflows from over-allocated sectors to purchase properties in under-allocated sectors.

Figure 1: Periods With the Largest Deviations from a 25% Target Allocation When Applying Changes in CBRE EA’s Value Index, Percentage Points