Exit Queues – July 15, 2024
It’s a phenomenon that historically has been a familiar aspect of the biggest holiday weekends: major transportation hubs and arteries jammed with travelers all looking to get out of town, although their destinations may differ. A similar effect has been seen lately in commercial real estate funds.
“Big-name property funds like Barry Sternlicht’s $10-billion Starwood Real Estate Income Trust have been scrutinized for limiting investor withdrawals from niche funds that exploded in popularity among the well-heeled over the past decade,” MarketWatch reported earlier this month.
“But investors with millions of dollars at their fingertips aren’t the only ones frustrated by funds putting up gates. Outflows and redemption queues also have been piling up at mainstream funds.”
Such queues have hit roughly 95% of the National Council of Real Estate Investment Fiduciaries’ benchmark “Odyssey” index, MarketWatch reported, citing a person with direct knowledge of the matter. Officially, it’s known as the NFI-Open End Diversified Core Equity index, with Odyssey serving as a convenient homonym for the index’s acronym (ODCE). It consists of 25 funds totaling $289 billion of gross real estate assets or, measured differently, $234 billion of net real estate assets.
Although the open-end fund strategy appeals to pension funds and registered investment advisers as a lower-risk way to invest beyond bonds and stocks, funds in the Odyssey index have been swept up by “the same higher borrowing costs, falling property prices and wave of maturing debt that has roiled the broader market since 2022, when the Federal Reserve began jacking up interest rates to a two-decade high,” reported MarketWatch.
NCREIF doesn’t track redemption queues or widely distribute its data on fund flows. However, a spokesperson confirmed to MarketWatch that the group of funds had negative net flows for the past six quarters, representing nearly $19 billion.
That being said, the most recent quarterly report from NCREIF, reflecting the first quarter of 2024, showed an improvement in flows compared to Q4 2023: still negative at -2.37%, but less so than the previous quarter’s -4.83%.
Adrianna Giesey, a portfolio manager at Russell Investments, told MarketWatch that investors waiting in redemption queues have been receiving payments in “drips and drabs” since reduced transaction volume put pressure on liquidity at many core open-end funds.
Typically, MarketWatch reported, when a fund puts up gates on redemptions, it works something like this: An investor with a $100-million exposure to an index might put in a $10-million quarterly cash-out request. However, redemption limits mean they might receive only $1 million back.
The U.S. has about 2,400 commercial real estate funds dedicated to the five main property types, according to CoStar Group’s Chad Littell. Most focus on areas other than core strategies. As a group, they’ve been notably less active over the past few quarters.
“It’s been hard to find price discovery,” Giesey told MarketWatch, referring to the sharp drop in U.S. property transactions since the Federal Reserve began raising its policy rate to the current 5.25% to 5.5% range.
However, one thing that could bolster confidence in CRE would be a Fed pivot to rate cuts, which is expected later this year—with Chair Jerome Powell’s testimony before Congress last week helping to fuel those expectations. That’s the case even though Powell said the stress that CRE investments have been under has been with us for some time and will probably continue for years.
“The hope is that steadier benchmark rates could help determine if property prices have finally found a floor,” reported MarketWatch. It’s likely that we’ll have a clearer picture by the end of this year.