The Importance of Considering Regimes in Long-term Asset Allocation to Real Estate

We investigate the long-term, regime-dependent asset allocation of an investor’s wealth in a mixed-asset portfolio that includes publicly traded real estate. We show that augmenting standard VAR models with Markov-switching features not only improves predictive power for asset returns but also introduces economically meaningful horizon effects in optimal portfolio allocations. As the investment horizon lengthens, optimal portfolio allocations become less sensitive to the prevailing regime. Across initial states, the sensitivity of portfolio allocations to the investment horizon manifests primarily through a gradual reallocation toward risky assets relative to risk-free assets, particularly at lower levels of risk aversion. Public real estate receives economically meaningful portfolio allocations under these conditions. Out-of-sample portfolio tests further show that regime-switching models deliver higher realized utility and Sharpe ratios than linear and i.i.d. benchmarks. Overall, the results highlight the economic value of incorporating regime shifts into longterm portfolio choice and confirm the continued role of publicly traded real estate in mixedasset portfolios.