As the commercial real estate market becomes increasingly globalized and as diversification—by market, by sector, by strategy type—has grown in importance, a new global real estate performance index has been created to help real estate investors make informed decisions about how to allocate their money within that global framework.
Recently, INREV, the European association for investors in non-listed real estate, ANREV, an association for investment in non-listed real estate vehicles in Asia, and U.S.-based NCREIF launched the global ODCE index, measuring the performance of 50 non-listed real estate funds across the U.S., Europe and Asia Pacific with total gross asset value of approximately $403 billion.
The quarterly index is calculated based on fund-level data provided to the three organizations directly by fund managers and is supposed to be published 10 weeks after each quarter’s end. It also offers a look at the performance of non-listed real estate funds going back to the second quarter of 2016.
To learn more about what was behind the efforts to bring a global index to life, how it is being calculated and what it can offer real estate investors of all sizes WMRE spoke to Iryna Pylypchuk, director of research and market information with INREV.
The following Q&A has been edited for length, style and clarity.
WMRE: So, my first question is how and when did the idea for the ODCE global index come about?
Iryna Pylypchuk: Maybe a little bit of background. INREV, NCREIF and ANREV formed a global alliance many years ago with the idea to provide consistency, standards and transparency for the non-listed real estate globally. We are organizations that work in the regions individually, but as we saw the global investment market expand and investors growing in terms of their global strategies, it became really clear how important it is to have more consistency and information when it comes to the global markets. So, this is when the global real estate fund index was born.
And, naturally, as we progressed, we also launched the global IRR index, which is designed to measure specifically the performance of value-add and opportunistic funds in particular. Because it’s an internal rate of return this is very relevant for those investors who are interested or invested in close-end vehicles. And the idea behind the global ODCE, which was only launched this summer, was to give even more understanding for the market, when it comes to the core peer group.
The ODCE as a peer group is very well established, with more than 40 years of history in the U.S. In the last 10 years or so it’s grown quite substantively both in Europe and also in Asia Pacific. This peer group is very clearly understood by the industry. It’s a very tightly-defined peer group, so one needs to meet inclusion criteria in terms of diversification and core as a strategy in order to qualify, and that gives a very strong reference to the investor who operates globally on what the performance on the very core end of the market is. Not only on an individual regional basis, such as Europe or Asia Pacific or the U.S., but also globally. That’s really the importance of this index. It’s a peer set to provide very clear understanding of the core end of the market and the performance.
WMRE: In the press release announcing this global index it mentions that one of the goals is to increase transparency. And so, if you can talk a little bit more in-depth about how this is going to be achieved?
Iryna Pylypchuk: Of course. There are two or three components, let me try to break it down. First of all, as I explained earlier, this is a very clearly defined and understood peer group—the global ODCE, or ODCE funds themselves—they are open-end diversified equity core funds. We have very strict inclusion criteria, and we try to be as aligned between the three regions [as possible] when it comes to the ODCE subsets. Therefore, when combining into the global index, it gives a unique insight and understanding into the global ODCE performance, which is consistent in terms of how it’s aggregated and measured.
That level of information is really powerful because it’s consistent, but also because there’s no equivalent of core index for the non-listed real estate on the global level, and that’s why it makes it such an important step in terms of providing transparency. The second component is the fact that it’s perceived as a strong reference point to understanding the core performance across the markets in general. And the third is a little bit of longer-term ambition, but effectively it is to be able to provide information from the asset to fund level reconciliation perspective.
When we achieve that goal—hopefully in a few years’ time—we will be in position to allow the investors to understand what the drivers of performance are, be it markets, sector selection or even asset selection. So, again, there is a long journey starting from providing consistent peer group performance at the regional level that is clearly understood to then aggregating that up into the global index to provide a global reference, which is now what we are doing with the global ODCE index, and then future developments in terms of effectively having more explanatory power of drivers of performance.
WMRE: Something we did want to zero in on is the reason why there was a feeling there was a need for a global index vs. having the country-by-country and regional ones?
Iryna Pylypchuk: Well, I think we are catering to the demand from the markets. If you look back over the last 10 or 15 years, there has been significant growth of global strategies and global investment in general. And I think the purpose of having a large global portfolio and offering diversification with it needs to be met with the data, and understanding the performance, and also the differences in performance and market strategies between Europe, Asia Pacific and the U.S. This is also a very important reason we are serving the market as it matures and as investors have become much more global in their nature. The second component is the fact that, like I’ve mentioned before, but I am just going to say it again, the fact that it’s such a clearly defined peer group, which is taken as a reference point for core performance.
WMRE: And then if you can talk about the nitty gritty, the details about how the index is calculated each quarter?
Iryna Pylypchuk: Effectively, it’s an aggregation of funds’ performance in each region. It follows the same methodology as GREFI, so its returns are value-weighted on all funds in each region. The coverage now is all of the ODCE funds of ANREV, all of the ODCE funds of INREV, and all of the ODCE funds of NCREIF. There are eight funds in Asia Pacific, 16 in Europe and 25 in the U.S. The aggregation takes place on an equal weighted basis across the three regions because that’s representative of the broader market.
Otherwise, if we just weigh it by value, it would be very heavily skewed to North America, to the U.S. The idea is to represent the broader market, that’s why it’s equally weighed between the three regional indices. And, of course, these are total returns, which are net of fees and they are reported in currency returns, which for both ANREV and INREV, so Asia Pacific and Europe, they are converted to U.S. dollars. Something to keep in mind is that for both Asia Pacific and the European currency the net total return is affected by this at the local reporting level, which of course is not affected for the U.S. ODCE because it’s already in U.S.D. as a currency.
WMRE: So in the number of funds, you said, it’s eight in Asia Pacific, 16 in Europe and 25 in the United States?
Iryna Pylypchuk: The U.S. is the one with the longest history of ODCE. That’s where the ODCE as a concept, as a peer group was born, with data going back more than 40 years, so it’s a very clear and established peer group. It’s taken off in Europe and Asia Pacific over the last 10 to 15 years, but in the last five in particular. We expect that to continue because they offer diversification benefits and quite an easy access to the global or the regional portfolio, which is diversified in core across different markets and sectors, which is a very strong advantage for investors, including the medium-sized or smaller investors. That’s their way of accessing diversified regional or global portfolio.
WMRE: Where can investors access your findings?
Iryna Pylypchuk: All of the data is available through the three organizations. So, for the global indices, be it GREFI, global IRR or the global ODCE, all of those indices are available to the members of the three organizations in the global alliance. As part of the global publications, there is also a regional performance at a high level, which normally other organizations wouldn’t have access to, so I think it’s an additional benefit as a member. Also, for INREV and ANREV, there is a snapshot version, which shows the very high level results, which is available publicly and the idea behind that is to give access to information and data, albeit at a higher level, to the broader market beyond our membership.
WMRE: So, we are in early October now, after the end of the third quarter. I don’t know if you have had the chance yet to glance through the results or if that is still being analyzed. If you can talk about what the latest readings that you have tell us about the state of the global non-listed real estate investment market?
Iryna Pylypchuk: We just ended the third quarter, which means we only started the data collection. You probably know it very well in our industry we are quite slow, it takes a long time to prepare the data. At this point in time we are just starting the data collection for Q3. Having said that and given the latest results—but also the extent to which there is still very little activity in the transactional market—the valuation adjustments have been slow, particularly in Europe, but also in the U.S. And although we see some signs of interest rate hikes either slowing or potentially even normalizing at this elevated new norm level, I think it would be quite difficult to see a change in sentiment, a change in performance radically different to what we have seen in the last few quarters.
I don’t have a crystal ball, but the radical change in performance is quite unlikely. I think we’ve got a few more quarters at least of correction, and the return of investor confidence in valuations and values coming together before the activity will naturally revive again in the investment market and there is a more consistent and steady flow of capital and confidence back into the market. I think that requires a few more quarters to work through, especially given the negative sentiment towards office like we see particularly in the U.S., and to some extent, although to a lesser degree, in Europe. So, I think this slow correction will continue for a little while longer.
WMRE: It’s interesting, when we were talking to people at the beginning of the year, they were saying that they expected this adjustment to maybe happen by the fourth quarter of 2023. But it doesn’t seem like it’s going to happen?
Iryna Pylypchuk: I will give you an example, I think a good example always is the U.S. market or the U.K. market. We talk about the U.K. market because certainly in the European context, it normally leads the recovery, leads the correction. And we have seen the performance of the U.K. turning positive for the very first time, albeit it’s very marginally positive. We are talking about less than 10 basis points in Q2. But even then, you still see quite a bit of negative sentiment, particularly towards offices. We still see investors sitting on the sidelines, so we don’t see a return of investment activity, which suggests that investors are not yet confident that all of the pricing corrections took place.
And then if you see U.K. as a leading indicator, and the U.S. usually is one as well, although this time around U.S. has been slower to correct, [you can extrapolate to the rest of the global market]. I think the economic outlook in some markets is less positive than in others. We still have elevated inflation expectations for this year, of course, and somewhat for next year. I think the normalization of interest rates and further adjustments in values are required before investors will come back and that natural transaction market picks up and that will bring more evidence in terms of where values are at and more visibility into to what extent we are through in this correction cycle. But yes, Q4 is unlikely.
WMRE: You mentioned that the U.S. market tends to be a leading indicator, but it has been slower than normal in this cycle. How much time is it taking for the U.S. market to adjust versus historically?
Iryna Pylypchuk: I don’t have the data in front of me, but normally, U.S. tends to move first in terms of the correction, and then U.K. follows, and then the continental Europe follows. Asia is somewhere in an interesting place because, of course, in some of the Asian markets interest rate policy is in a very different place and the market performance is stronger in some [places]. It’s very similar to what we see here in mature Western economies. But this time around we saw less of a correction in the U.S. than in the U.K. It could be that, to some extent, if we compare to the Global Financial Crisis, that event was rockets, it was very much influenced by enforcement by the banks. We don’t see it happening to the same extent this time around. It feels like there are a lot more negotiations around the table rather than giving back the keys. And because, to some extent—not all the segments of the market, but in many places—the occupier fundamentals, maybe perhaps with the exception in U.S. offices, are still holding fairly healthy. There was no particular trigger that has caused a rocket correction this time in the U.S. Whereas the U.K. has just taken a more rigid approach, with values taking more transactional market evidence, and sentiment evidence in particular, into account when it comes to valuations.
WMRE: Is there anything else about the global index, or even just about the movement toward more global investment that we haven’t talked about that you think is important to mention?
Iryna Pylypchuk: I think the only part which we didn’t touch upon is the ability to diversify and take advantage of different markets’ position, be it from their global perspective or bigger trends, mega trends, like the demographics, or the socioeconomic changes as well. I think that’s why access to and understanding of the global data is so important, and ability to choose which sectors or which markets to operate in when you have the global visibility. I think the more data, the merrier.
The more consistent it is, in terms of measuring performance, the better it is for investors because they can make more informed choices and, of course, [see] how different markets are performing and different regions are performing through cycles. I think that’s where the IRR index is particularly complementary because the IRR index concentrates not on the time-weighed returns, but internal rate of returns. Effectively, it allows you to look at the aggregate investor performance and interest. And because that index is also looking by the vintage year, you can compare and contrast how different funds are performing depending on the vintage and through different times in the cycle.
Hence, I think the benefit of having all three indices complementary to each other. You’ve got the GREFI, which is effectively the entire universe. Both core and non-core, both open-end and closed-end for INREV and ANREV, and open-end for NCRIEF. Then you’ve got the global ODCE, which is high core peer group, which is very understood and used as a reference. And then IRR, which is focused more on the closed-end funds with predominantly value-add and opportunistic strategies. So, it gives a lot more insights, depending on what data the investor is looking for, to understand the performance.