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Absence makes the [seller/lender/broker's] heart grow fonder...
This slide was buried toward the back of a recent Newmark capital markets update but highlights an underreported fact...
ODCE fund outflows started long before interest rates spiked.
This flies in the face of 'doom loop' narratives but could explain property value declines. More importantly, it could be a trend that's here to stay.
---- Background ----
What are ODCE funds?
"The NFI-ODCE is a capitalization-weighted, gross of fee, time-weighted return index with an inception date of December 31, 1977."
-- 25 infinite-life funds
-- About $300B in gross assets
-- 3,500 properties
-- 26% LTV
-- 92% occupancy
-- 33% industrial
-- 29% multifamily
-- 18% office
-- 11% retail
(Source: USQ)
---- Why do ODCE funds matter? ----
These funds make up a relatively small share of the total US CRE equity market (we estimate about 5%), but they're very important because...
"The term Diversified Core Equity style typically reflects LOWER RISK INVESTMENT STRATEGIES utilizing low leverage and generally represented by equity ownership positions in stable U.S. operating properties diversified across regions and property types."
In a nutshell, ODCE funds are supposed to be lower risk, lower return; they have the lowest cost of capital. Over 40 years, ODCE's average total return has been about 7%, which equates to an unleveraged IRR ("discount rate") of about 6%.
---- Enter Blackstone ----
Several factors likely explain the longer-term trend around ODCE outflows, but one hasn't received a lot of attention: Competition.
-- Blackstone launched a core plus fund in 2013 ($66B today).
-- 2 of the largest ODCE funds (PRISA and JPM's SPF) total about $60B.
-- Carlyle and KKR also have sizable core plus funds.
-- 100+ other funds have raised $40B targeting core plus returns.
---- Valuation ladder ----
Assume you're trying to sell a multifamily property with stable cash flows. Your sale price will largely depend on buyers' cost of capital...
ODCE: 6% disc rate, $110M price
Core+: 8% disc rate, $100M price (10% lower)
Value-add: 12% disc rate, $73M price (28% lower)
Opportunistic: 14% disc rate, $66M (35% lower)
If at all possible, you want to sell to an ODCE fund. If not, a core plus fund. If a "bottom fishing" closed-end fund, you'll probably kick the can. ...which is where we seem to be.
---- Q&A takeaways ----
Will some ODCE funds shrink?
Probably
Will ODCE funds see net inflows again?
Almost certainly
Will a few ODCE funds emerge as big winners?
Probably
Will ODCE funds start buying soon?
Unlikely
How far have property prices fallen?
22% peak-to-trough per Green Street
What's the price difference between core and core+ buyers?
Rough guess: About 10%
What share of declines could be due to ODCE funds being sidelined?
Rough guess: Possibly up to 45% (10% out of 22%)
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