Quarterly market review- Q1 2025

After the last two stellar and relatively stable calendar years (25%+ each year), volatility increased in the equity markets as the S&P 500 started the quarter with gains of almost 5% in mid-February before declining to finish with its first negative quarter since Q3 2023. Uncertainty around US trade and fiscal policy led to the decline. Fixed income did provide some ballast last quarter, largely driven by the decline in the 10-yr from 4.57% to close the quarter at 4.21%. For the third straight quarter, the NFI-ODCE generated a positive return. Consistent with the fourth quarter, the majority of property types experienced small gains in value, resulting in a marginally positive aggregate appreciation on top of a +1.0% income return. The NFI-ODCE's net return saw a slight decrease compared to the prior quarter, primarily due to the impact of declining interest rates (over 35 bps) on debt valuations.

After quarter-end, due to a rapidly changing current market environment, volatility has dramatically increased with the announcement of tariffs. Although President Trump implemented a 90-day pause on all reciprocal tariffs (except for China), the continuing uncertainty has wreaked havoc on markets. Immediately following the announcement of the 90-day pause, the S&P recorded one of its single best days in history – a reminder of why it is beneficial to stay invested regardless of the environment. Nevertheless, the optimism quickly abated after China retaliated with tariffs on U.S. imports. At the time of this writing the S&P 500 is down another -8% on the month.

While the equity markets have been increasingly volatile, the recent bond market volatility illustrated in the below return chart may be more concerning. The 10-year Treasury moved substantially, trading in a range of 3.86% to 4.59% during the first three weeks of April. Existing theories as to why yields have been so volatile include the unwind of basis trades, Chinese selling of Treasuries, inflation fears, recession fears, bond vigilantes, and investors losing their appetite for USD-based assets. While it is hard to discern the relative effects, the volatility will likely continue until trade negotiations come to fruition and there is clarity on fiscal policy. Regardless of the rationale, fixed income will not be an effective ballast in an environment where the 10-yr yield can rise 70bps in a matter of days.

The uptick in market volatility is a reminder of why it is important to invest in more diversifying assets. In a period of rising inflation, which seems to be the primary worry of the markets, real estate has long been a favored asset class and typically delivers positive returns. This leaves many to wonder why the asset class had struggled over the past few years. However, the decline was a result of the Fed raising rates at a historic pace rather than inflation. The Fed believed it was necessary to raise rates so aggressively because they were starting from such a low base. At this point, even if inflation is stickier than the Fed has hoped, the likelihood of a substantial increase in rates from here is relatively low. They are more likely to keep rates at the current level, and ultimately decrease rates, with continued deterioration in the economy. Some things that should be considered in the current environment:

• US real estate has been a great diversifier over its history, there is no reason to believe this won’t happen again, especially after the asset class just experienced the second worst drawdown in history. After values reset, we have typically seen many years of appreciation (10+ years).

• Most commercial real estate sectors experienced positive performance over the past two quarters. Office is the only outlier, and we continue to see slight declines. However, we are seeing activity pick up and believe any further decline will be marginal.

• Both multi-family and industrial are well positioned to experience appreciation. As higher rates have dramatically reduced starts, current stabilized assets should do very well in this environment and values should start to increase.

• Retail assets have seen appreciation over the past four quarters. This again is a reminder that markets change quickly and why it is important to stay diversified. Just a few short years ago, it was difficult to avoid the articles about the demise of retail and today it draws some of the highest demand across the industry.

• While the precise impact of tariffs and immigration on the real estate market is yet to be determined, current indications suggest a likely net positive outcome. Less immigration, an increase in the prices of building materials, and a higher cost of financing will increase the replacement cost of commercial real estate and keep new development muted. This again supports the case for stabilized assets in the current environment.

Outlook

While it is impossible to predict the future, we strongly believe maintaining an allocation to core real estate is warranted in this environment. In periods of volatility, commercial real estate has consistently been a great diversifier. Moving forward, private core real estate should particularly hold up well regardless of whether inflation remains elevated, or if inflation declines unexpectedly and the Fed can lower rates. If a recession takes hold, commercial real estate could see a period of muted returns, however we believe the asset class is much more attractive on a relative basis than equity markets, with multiples remaining well above average, or fixed income markets, where credit spreads remain tight.

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.

MSCI US REIT GR Index is a free float-adjusted market capitalization weighted index designed to capture the large, mid and small cap segments of the US equity universe. All securities in the index are classified in the Real Estate sector according to the Global Industry Classification Standard (GICS®).

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.