Quarterly market review- Q4 2024

Equity markets posted another positive quarter at the conclusion of 2024. The S&P 500 has now delivered back-to-back 25%+ annual calendar returns. This has many wondering if the run can continue and for how long. At these heights, we believe the more important question has become the magnitude of the pullback when it does occur, as well as its timing. Now may be a good opportunity for investors to diversify and re-balance towards asset classes that may be more fairly valued. Fixed income struggled over the quarter as the 10-year Treasury yield increased 77 bps, ending the quarter at 4.58%. Private real estate, as reflected by the NFI-ODCE NR, delivered a +0.96% return, potentially signaling the drawdown experienced over the past two years is now officially behind us.

Private real estate’s performance for the quarter was solidly in positive territory after turning slightly positive last quarter. As the index has now delivered its second quarter of positive returns, it gives us more conviction the asset class has turned. Historically speaking, when this inflection point has happened after previous drawdowns, investors have been rewarded with many consecutive years of positive returns. We believe this turning point has created a particularly compelling opportunity to re-balance or enter the private core real estate equity asset class, especially as the S&P is trading at a historically high P/E ratio.

From a macroeconomic perspective, the Federal Reserve has stayed the course on lowering rates, although it has also signaled that the pace of further rate cuts is likely to slow. Even though the Fed has been lowering short-term rates, we have seen a rise in the longer-dated treasuries, as the market has concerns about a pickup in inflation, fiscal policy, and the incoming administration’s economic policies. Some of this uncertainty is likely to be cleared sometime after the new administration takes office on January 20, 2025. Additionally, inflation has never moved linearly, therefore these upticks are somewhat expected. We are watching these developments closely but strongly believe commercial real estate has reached its inflection point, and the recent volatility in rates does not change that outlook. As investors enter the asset class, they should be prudent in selecting funds that have fully reflected the reset in commercial real estate valuations.

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 be very detrimental to investors when the market retreats. Private real estate is a great diversifier, as demonstrated in 2022, being 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 the last couple of quarters, 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 become increasingly positive moving forward.
• Residential — Residential was essentially flat with some slight appreciation. As the country remains under-supplied on homes and construction starts have fallen significantly, we expect multi-family will start to see appreciation again in the coming quarters.
• Office — Office properties continued their decline, but the pace of the decline again moderated. 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. Additionally, there may finally be signs of a much-awaited return to office, with many major corporations requiring five days a week in the office.
• Retail — The retail sector is benefiting from a strong economy and consumer spending. As a result, the property type again experienced appreciation for the quarter.

Outlook

In summary, this quarter’s return further supports our conviction that last quarter was the turning point, and we are expecting positive returns moving forward. Commercial real estate has long been a favored asset class for investors looking for stable, income-producing, non-correlated 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.

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.