Quarterly market review- Q3 2024

During the third quarter of 2024, equity markets continued making historic highs with the S&P 500 posting another strong return. Fixed income also delivered positive returns, as the 10-year dropped precipitously, ending the quarter at 3.81%. Private real estate, as reflected by the NFI-ODCE NR, delivered a very slight positive return.

Private real estate’s performance for the quarter finally turned positive after seven quarters of negative returns. Each time the NFI-ODCE index has reached an inflection point and turned positive after a drawdown, it has historically seen persistent positive returns. Although transaction volume remains low by historical standards, we have seen a number of transactions take place in the third quarter. Notably, a number of those transactions within the industrial and residential property types achieved stronger pricing than appraisal cap rates had implied. This positive sign gives us more confidence that valuation declines are now behind us for those property types. As we have mentioned in previous quarters, we continue to observe other non-traded / NAV REITs and competing interval funds that seemingly have not taken valuation declines reflective of the actual market and should be viewed with caution. Our conviction has grown even stronger that we have seen the inflection point, and for those that have recognized the losses, this repricing has created a particularly compelling opportunity to rebalance or enter the private core real estate equity asset class. As investors reallocate or enter the private real estate markets, understanding valuation and choosing the right vehicle is very important and will greatly influence prospective returns.

From a macroeconomic perspective, quite a bit has changed since the last quarter. The Federal Reserve finally started to ease monetary policy, beginning with a 50 bps cut. The Fed now believes risks are balanced and have shifted their focus to the labor markets, hoping that cutting rates now will avoid any unnecessary damage to employment. Through the hiking cycle, the employment picture had remained relatively strong and the consumer was surprisingly resilient. Now that the Fed is easing policy, the backdrop for commercial real estate is gaining strength. The asset class could be starting a long period of above-average returns based upon numerous factors: lower interest rates, solid employment, a resilient consumer, increasing demand for commercial real estate as investors look to move money out of cash, and a large decline in construction starts.

As a reminder, commercial real estate is not correlated to other asset classes, as shown below. But more striking in this chart is the high correlation among other major asset classes. While this has largely benefited investors over the past few years, it is important to remember why diversifying assets are critical. Given that equity markets are at all-time highs and are primarily being driven by a narrow subset of stocks, having highly-correlated assets may not benefit investors in coming quarters if the market retreats. Private real estate is a great diversifier, as demonstrated in 2022; it was one of the few assets that delivered positive returns (~7%) when every other major asset class had double-digit declines.

5-year correlation

Performance by property type

• Industrial — Similar to last quarter, industrial returns were flat across most funds, but we did see a decline in select parts of the country, namely southern California. As construction starts are down significantly and demand remains strong from onshoring and online shopping trends, we expect industrial returns to normalize moving forward.
• Residential — Residential was essentially flat with some slight declines. However, the market transactions that have taken place over the past 90 days have been stronger than appraised values. This should help residential returns strengthen from this point forward.
• Office — Office properties continued their decline, but the pace of the decline is moderating. At this point, we believe the office properties held within the NFI-ODCE index are more reflective of fair market value and will have a less meaningful impact going forward.
• Retail — The retail sector is benefiting from a strong economy and consumer spending. As a result, the property type experienced appreciation for the quarter.

Outlook

In summary, we believe the inflection point was this quarter and are expecting positive returns moving forward. Commercial real estate has long been a favored asset class for investors looking for stable, income producing, non-diversified assets. As most other asset classes seem to be relatively overvalued, diversifying into private real estate at this point has historically rewarded investors.

Definitions

Cap rate represents the annual rate of return on based on the income that the property is expected to generate.

Bloomberg U.S. Aggregate Bond Index is an unmanaged market value-weighted index for U.S. dollar denominated investment- grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year.

MSCI EAFE Index is a free float-adjusted market capitalization index that measures the equity market performance of 21 developed market countries.

MSCI EM Index is a free float-adjusted market capitalization index that measures the equity market performance of 24 emerging market countries.

NCREIF Fund Index — Open-end Diversified Core Equity (NFI-ODCE) consists of private real estate equity funds that meet certain criteria with respect to such things as leverage (less than 35%), operations (at least 75% invested in properties that are 75% or more leased), sector and geographic diversification, and investment in core real estate (at least 75% in office, industrial, apartment and retail properties).

S&P 500 Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.

S&P US REIT Index measures the investable U.S. REIT market and maintains a constituency that reflects the market's overall composition.

Past Performance is no guarantee of future results. One cannot invest directly in an index.

Risk Disclosures

Union Square Capital Partners, LLC is an investment adviser registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Past performance does not guarantee future results.

There are a number of significant risks that should be considered when considering an investment in real estate or real estate related securities. No amount of diversification or correlation can guarantee profit or prevent losses. This website is neither an offer to sell nor a solicitation of an offer to buy any securities. An offering is made only by the applicable offering documents or Prospectus and only in those jurisdictions where permitted by law. This website must be read in conjunction with the applicable offering documents or Prospectus in order to understand fully all of the implications and risks of the offering of securities to which it relates and a copy of the offering documents or Prospectus must be available to you in connection with any offering. All information contained in this website is qualified by the terms of applicable offering documents or Prospectus. Neither the United States Securities and Exchange Commission nor any state regulator has approved or disapproved of the merits of any offering described herein. Any representation to the contrary is unlawful.