Dynamic Portfolio Choice with Real Estate under Transaction Costs

Abstract: This paper finds the optimal multi-asset strategy for investing in rent-paying real estate incurring transaction costs at purchase and sale with shadow price arguments alongside dividend-paying stocks and zero-coupon bonds. The derivations show the no-trade region to widen 2^(1/3) folds compared to the case with transaction costs at sale only. The analysis demonstrates the strategy's applicability to an indivisible real estate asset setting. The multi-asset portfolios of this model with house, stock, and bond statistically outperform the conventional stock-bond portfolios from Merton’s portfolio problem for investment horizons above one decade, given the commitment of initial capital affording to land in the no-trade region.