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Market Update

Quarterly market review - Q3 2022

October 1, 2022
  • Thomas Miller for USQ


    Thomas Miller

    Managing Director
    USQ Interval Funds

    Kennett Square, PA


The third quarter of 2022 provided no relief for investors. The S&P 500 posted a negative return of -4.88% for the quarter and is down over -23.87% for the year. Fixed income returns were also negative posting a return of -4.75% (Bloomberg U.S. Agg. Bond Index TR). Publicly traded REITs (as measured by the MSCI US Real Estate Index NR) moved in line with the broad markets, as they typically do in periods of volatility, posting a negative -9.96% return. Core private real estate (as measured by the NFI-ODCE NR) moderated, but still posted a positive return of 0.35%. The resilience of core private real estate returns cannot be overlooked in times such as these. Diversifying into other asset classes, especially private markets, should continue to be considered as the public equity and fixed income markets are likely to see continued volatility.

The Federal Reserve’s quest to halt inflation is wreaking havoc across public equity and fixed markets. Heading into this quarter, investors were certainly expecting rate increases. However, the rapid rise in rates has not factored into the inflation data as of yet, and the Federal Reserve seems unwilling to pivot from its hawkish stance until the lagged inflation data shows signs of breaking. The good news is that headline inflation did retreat as the price of oil, lumber and shipping costs all showed significant declines. Additionally, the labor market remains extraordinarily tight, which is typically a sign of strength in the economy. That said, the tight labor market is leading to wage growth that the U.S. has not seen in decades, adding to inflationary pressures. Fortunately for commercial real estate, employment growth is a driver of demand.

Speaking of commercial real estate, we continue to believe the asset class remains well-positioned in the current environment. Returns have certainly moderated as cap rates have increased, but the rent growth across multi-family and industrial have largely offset the valuation declines seen to date. We expect this moderation to continue and believe that returns will normalize moving forward, which has historically been 6-8% annualized. Rent growth remains strong which has not been fully realized but will be in the coming quarters as leases renew. As a reminder, through most economic environments, private core real estate has generally delivered consistent positive returns – the exception being when commercial real estate markets were over levered and over supplied, neither of which are present today. As such, high quality commercial real estate remains in high demand.

Below is a brief summary by property type:

  • Industrial properties’ return greatly moderated during the quarter. Cap rates did rise, especially in properties with longer dated leases, but rent growth remains strong and demand in the best markets across the U.S. continues to exceed supply.
  • Multi-family saw strong appreciation. Strong rent growth persists and is likely to continue as many potential homebuyers are not able to purchase homes with residential 30-year fixed rate loans topping 7%.
  • Office properties largely remained flat over the quarter. We are seeing increased leasing activity within certain markets. Furthermore, many companies continue to implement return to office plans as the impact of Covid-19 fades.
  • Retail properties continue to experience meaningful increases in net operating income (NOI). Grocery anchored and necessity-based centers continue to perform well, and experience-based Class-A retail is benefiting as the economy has now fully reopened.
  • Specialty: We continue to see strong demand from institutional investors for more specialty type property sectors such as self-storage and single-family residential. While these sectors currently represent a small portion of the NFI-ODCE, their returns have been very strong and added to the strong overall performance.

Will office survive?

A common question we receive is regarding office space although it is now less than 20% of the NFI-ODCE index. While the mainstream media loves to paint a picture that no one will return to the office, it is quite a bit more nuanced and not what is taking place. In fact, New York City, one of the slowest markets to recover from the pandemic, had the strongest period of leasing activity in Q3 2022 since before the pandemic began. That said, availability remains high, but what is clear is that office properties that offer best in class amenities are going to win in this environment.

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

Bloomberg U.S. Aggregate 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 U.S. REIT Index is a free float-adjusted market capitalization index that is comprised of equity REITs. With 132 constituents, it represents about 99% of the US REIT universe and securities are classified in the Equity REITs Industry (under the Real Estate sector) according to the Global Industry Classification Standard (GICS®). It however excludes Mortgage REIT and selected Specialized REITs.

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.

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.

About the author

  • Thomas Miller

    Managing Director
    USQ Interval Funds

    Kennett Square, PA