Diversification Potential in Real Estate Portfolios

Real estate, despite its spatial fixity, is subject to considerable cross-border investment flows. However, it may be surmised that the diversification potential of international real esta te investments dwindles if markets become increasingly interlinked. Building on a unique dataset of direct real estate markets covering 16 OECD countries over the period 1999-2018, we compare country-level and sector-level diversification potential. We apply a relative Sharpe ratio loss approach and develop a modified version of this measure, relying on the modified Value-at-Risk, which is robust to non-normality. Using a studentized circular blockbootstrap procedure, robust confidence intervals for both measures are built. This new diversification test provides investors and analysts with a valuable tool as it delivers both estimates and robust significance levels. The empirical findings broadly reveal that international diversification strategies outperform sectoral diversification of real estate assets.