Dual Divergences in Real Estate Markets

The real estate sector faces two simultaneous divergences creating opportunity and complexity. The first: public REIT valuations versus private real estate valuations, measured through cap rate spreads. The second: REIT valuations versus broader equity markets, measured through forward P/E and P/FFO ratios. Together, these suggest public markets are mispricing real estate assets.

The public-private cap rate spread of 112 basis points in Q3 2025 represents a record-long dislocation. Cap rates, the ratio of net operating income to property value, provide standardized measures for comparing valuations across public and private markets. When public REIT cap rates are significantly higher than private market cap rates, it indicates public markets value real estate more conservatively.

This spread has historically been much narrower, typically 20-50 basis points. The current 112 basis point spread suggests either public REITs are undervalued relative to private real estate, or private real estate is overvalued. Given private market transactions involve sophisticated institutional buyers conducting extensive due diligence, evidence suggests public REITs may be undervalued.

The second divergence provides additional context. The S&P 500 forward P/E ratio of 1.3 times the equity REIT forward P/FFO ratio represents a significant deviation from the historical average of 1.0. This suggests public equity markets value REITs at a discount relative to broader market valuations, even as REITs own the same types of real estate assets private markets value at premium levels.

This dual divergence creates a compelling investment thesis. If private markets correctly value real estate assets, and public REITs own similar assets but trade at discounts, then REITs represent an opportunity to access real estate exposure at prices not reflecting underlying asset values. Convergence of these gaps, whether through REIT price appreciation or private market adjustment, could deliver significant returns.

The persistence of these divergences reflects several factors. Public market investors may discount REITs due to concerns about interest rate sensitivity, economic uncertainty, or sector-specific challenges. Private market investors focus on long-term fundamentals, supply constraints, and income generation potential public markets overlook. The extended duration suggests public market sentiment may be slow to adjust, creating opportunity for patient investors.

JLL's Global Real Estate Outlook points to a strengthening capital markets environment in the second half of 2025, with momentum expected to build into 2026. This assessment, combined with valuation divergences, suggests conditions may be aligning for REIT outperformance as public markets recognize value private markets have already identified.

Historical Precedent for REIT Outperformance

Historical analysis provides compelling evidence current valuation gaps will converge through REIT outperformance rather than private market adjustment. REIT.com's analysis of previous periods when public-private cap rate spreads reached similar levels reveals a consistent pattern: REITs significantly outperformed private real estate in the four quarters following peak spreads, delivering average returns of 41.7%.

This pattern reflects fundamental dynamics of public versus private market pricing. Public markets adjust valuations quickly as new information emerges, sentiment shifts, or economic conditions change. Private markets adjust more slowly due to transaction costs, due diligence requirements, and illiquid nature of direct real estate investments. When public markets undervalue assets relative to private markets, correction typically occurs through public market appreciation.

The historical precedent extends beyond the public-private spread. During the Global Financial Crisis, when REIT valuations diverged substantially from broader market valuations, REITs subsequently outperformed the S&P 500 by 56.9% as the gap closed. During the COVID-19 pandemic, when REITs again traded at discounts, they outperformed the S&P 500 by 12.6% as markets recognized resilience and income-generating characteristics.

These patterns suggest current dual divergences will resolve through REIT outperformance. The magnitude of current gaps, combined with strength of historical precedent, creates a compelling case for REIT allocation as a tactical opportunity within broader real estate and alternative asset strategies.

The mechanism involves several factors. First, as public markets recognize value discrepancy, REIT share prices appreciate to reflect underlying asset values more accurately. Second, REITs can take advantage of public market access to acquire assets at prices reflecting public market valuations, creating value through arbitrage opportunities. Third, as REIT performance improves, investor sentiment shifts, attracting additional capital and supporting price appreciation.

Timing of convergence is difficult to predict, but historical patterns suggest significant gaps tend to close over one to four quarters. The current 112 basis point spread has persisted for an extended period, suggesting convergence may be overdue and could occur more rapidly when it begins. Investors positioning themselves before convergence occurs can capture full benefit of valuation adjustment.

Private Market Transactions Validate Thesis

Major private market transactions validate the thesis that real estate assets are worth more than public REIT valuations suggest. Blackstone's $2.3 billion acquisition of Alexander & Baldwin, a major Hawaii commercial real estate owner, was executed at a 40% premium to the company's stock price, signaling strong conviction in supply-constrained markets and underlying asset values.

This transaction is significant because it represents a sophisticated institutional investor, one of the world's largest alternative asset managers, paying a substantial premium to acquire real estate assets public markets valued at lower levels. Blackstone's due diligence process is extensive, involving detailed analysis of property fundamentals, market conditions, and long-term value creation potential. Their willingness to pay a 40% premium suggests their assessment of asset values significantly exceeded public market pricing.

The transaction highlights supply constraints JLL identifies as a key factor supporting real estate values. U.S. office completions are set to fall by 75% in 2026, while industrial and logistics deliveries are expected to be 42% below their 2023 peak. These supply constraints, combined with strong demand fundamentals, create conditions supporting real estate values and justifying premium pricing for well-located, high-quality assets.

Data centers represent an exception, with capacity forecast to surge by 19% in 2026, driven by the AI boom. However, this sector-specific dynamic doesn't undermine the broader thesis, as data centers represent a distinct asset class with unique demand drivers.

The Alexander & Baldwin transaction, along with other major private market real estate transactions, provides evidence sophisticated capital recognizes value in real estate assets public markets may be overlooking. This validation is important because it suggests valuation gaps aren't merely theoretical, but reflect real opportunities for investors accessing public market pricing while benefiting from asset values private markets recognize.

The premium paid in private market transactions also creates a floor for public market valuations. As private market buyers demonstrate willingness to pay substantial premiums, public market investors may reassess valuations, leading to price appreciation in REITs owning similar assets. This dynamic can accelerate convergence between public and private market valuations.

Investment Implications

The dual divergences, combined with historical precedent and private market validation, create compelling investment implications for investors seeking real estate exposure and alternative asset allocation.

For investors with existing real estate exposure, valuation gaps suggest REIT allocation may offer superior risk-adjusted returns compared to private real estate in the near term. The ability to access real estate exposure through liquid public market structures, while benefiting from underlying asset values private markets recognize, creates an attractive opportunity. However, investors must consider REITs provide different characteristics than direct ownership, including daily liquidity, transparency, and correlation with broader equity markets.

The connection between REIT opportunities and broader portfolio construction trends is relevant for investors implementing 60-20-20 or similar alternative asset allocation strategies. REITs can provide real estate exposure within public market allocations, while private real estate provides exposure within alternative allocations. Current valuation gaps suggest public market REIT exposure may offer superior near-term returns, while private real estate provides long-term diversification and income generation. This aligns with broader trends in real estate as an inflation-protected alternative asset.

For investors considering new real estate allocations, valuation gaps create a timing opportunity. Allocating to REITs when public markets undervalue assets relative to private markets can enhance returns as valuations converge. However, investors must recognize timing markets is challenging, and real estate should be viewed as a long-term allocation rather than a tactical trade.

Historical precedent for REIT outperformance following similar gaps provides confidence the current opportunity isn't merely theoretical. However, investors must recognize past performance doesn't guarantee future results, and market conditions, economic factors, and sector-specific dynamics can influence outcomes differently than historical patterns suggest.

Supply constraints identified by JLL, including the 75% decline in office completions and 42% decline in industrial deliveries, support the thesis real estate fundamentals are strong. However, investors must consider sector-specific dynamics. Office real estate faces challenges from remote work trends, while industrial and logistics real estate benefits from e-commerce growth.

For family offices and institutional investors, valuation gaps create opportunities to enhance real estate allocations through REIT exposure while maintaining private real estate holdings for diversification. The ability to adjust allocations between public and private exposure based on relative valuations can enhance portfolio efficiency and returns.

The connection between real estate opportunities and broader alternative asset trends is relevant. As investors increasingly allocate to alternatives, including through democratized access structures, demand for real estate exposure may increase, supporting both public and private market valuations. The convergence of public and private real estate markets reflects similar dynamics to those seen in real estate secondaries and private equity mega-deals, where institutional capital deployment is transforming alternative asset markets.