This paper studies diversification and value in the investment portfolios of (non-listed) Real Estate Investment Funds (REIFs) exploring how the value of diversification is captured by the market and by investors (beyond reported valuations).
We apply the Herfindahl-Hirschman Index (HHI) to study the level of concentration versus diversification in the investment portfolios of REIFs (both in terms of segment and geographical diversification). We use a dataset from INREV with data from 62 investment portfolios, with an average of 86 REIFs per portfolio for the period of 2008–2020 (to study segment diversification). We use a second dataset from INREV with data from 30 investment portfolios with an average of 79 REIFs per portfolio for the period of 2005–2020 (to study geographical diversification). We employ a cluster analysis approach to identify common features among the investment funds.
We conclude that (segment diversified) portfolios with higher degrees of leverage exhibit higher income yields, albeit diversification is captured indirectly through asset choices – more diversified portfolios tend to exhibit a stronger risk and return relationship. Also, geographical diversification creates value (more significantly by for the correct combination of countries carefully choosing what different geographies to group in the diversified portfolio).
One limitation of our study is that our portfolios are funds of funds, since the available data could not reach the asset detail, but we believe this does not compromise our results.
Diversification leads to higher risk-adjusted returns which suggests that properties may be undervalued (market value) in the framework of the Gordon Model, contrary to expectations (regarding investment value).
Investors capture the value of diversification differently, suggesting a gap between market value and investment value that can be explored.
