This paper reveals the limitations of the classic Modern Portfolio Theory (MPT) and the fallacy of applying this theory to a mixed-asset portfolio that includes real estate. The findings suggest that the validity of the single-period MPT to multi-period investment is critically conditional on the assumption that asset returns over time are independent and identically distributed (i.i.d.) and that the real estate returns are far from this assumption. Furthermore, the analysis shows that the unique characteristics of real estate greatly complicate the mixed-asset portfolio decisions, and the long standing "real estate allocation puzzle" may be caused by the direct application of MPT to the mixed-asset portfolio.
