How the NFI-ODCE funds mitigate risk
Summary
We have long believed having an allocation to the NFI-ODCE is important for risk mitigation in your real estate portfolio. Looking at today’s commercial real estate market, the following highlights why having this exposure may help:
Leverage
As many headlines have pointed out, the rising interest rate environment can be challenging for real estate owners, especially those that are highly levered. Higher rates make it difficult to refinance existing loans and slow transaction volumes, as most real estate is purchased using leverage. NFI-ODCE funds have a unique advantage in this environment for the following reasons:
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NFI-ODCE leverage is currently just 25%* and is taken at both the property and fund level.
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Many properties have no debt, and each portfolio is well-diversified by property type.
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All these factors give the manager maximum flexibility with limited refinance risk as it relates to any specific asset.
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The vast majority of the current outstanding debt does not mature until after 2026+. There is a small amount of debt that matures in 2024.
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Most of the NFI-ODCE funds have multiple sources of capital including large banks and insurance companies.
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Diversification
Much of the news as of late in regard to the potential issues surrounding commercial real estate are focused on the office sector, and specifically Class B/C office, although the headlines would lead many to believe it is a broader problem related to the commercial real estate market as a whole. As workers have not fully returned to the office and some office debt may be coming due, this may in fact be a challenging time for some office owners. However, office is a relatively smaller part of the commercial real estate market. As it relates to the NFI-ODCE:
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Office makes up only 18%* of the index. Also, Class A office, which is the focus of many of the NFI-ODCE funds, has fared much better and is actually seeing increased leasing activity within certain markets.
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Almost 66% of the index is invested in industrial and multi-family properties, two of the best performing sectors in the last 24 months. Additionally, the outlook for these two sectors looks very strong moving forward.
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The NFI-ODCE is comprised of 25* actively managed private funds that allow the managers to take advantage of market conditions and shift allocations accordingly. For example, office exposure has been significantly reduced over the past 5 years.
Quality of the tenant base and occupancy
What is not being reported in many news articles is the fact that, with the exception of office, occupancy and rent growth continue to be strong across many of the sectors. As it relates to office workers being physically present in the office, levels are certainly not back to pre-pandemic levels, however, hybrid work is growing in popularity over fully remote. Hybrid still requires office space to account for days when many workers are present. For example, many articles point out that, on average, only 50% of office workers have returned to the office. However, when looking at that same metric daily, it shows that number is almost 60% on days when most hybrid workers are there. Finally, while offices may not be fully occupied, that should not be confused with not being fully leased. Even as companies move to hybrid or remote work, they will still honor their long-term lease obligations. Therefore, in times such as these, when the economic picture is more challenged and when many corporations are allowing hybrid work arrangements, understanding the tenant base is of paramount importance. In regards to the NFI-ODCE:
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Occupancy remains very strong at 93%*.
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Since most of the real estate owned by ODCE managers is of the highest quality, it attracts high-quality tenants. Focusing on high quality tenants mitigates risks in uncertain times.
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Even within office, ODCE occupancy is ~85%*. This highlights the focus on Class A office, which has not seen the drastic declines in occupancy that Class B and Class C office have experienced.
* Source: NCREIF Fund Index - Open End Diversified Core Equity (NFI-ODCE) Value Weight Index as of June 30, 2023.
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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.
