New NCREIF data for commercial real estate performance in 2020 underscores what industry participants had anticipated—it was a tough year for appreciation and income. Although rental income did hold up better than some had feared, the NCREIF Property Index (NPI) shows a total annual return of 1.6 percent, while the NCREIF Open‐end Diversified Core Equity Index (NFI-ODCE) posted an annual return of 1.2 percent. That pales in comparison to the 18.4 percent return in the S&P 500 but beats the -5.12 percent return on the Nareit All Equity REIT Index.
“Under the circumstances, the uncertainties in the market and the uniqueness of the downturn, those results are not surprising,” says Sam Chandan, PhD, dean of NYU’s Schack Institute of Real Estate. “While the year returns are understandably lower than what we saw in the pre-pandemic period, I think the key takeaway is the healthy rebound in returns in third and fourth quarters,” he says. For example, the total return for the NPI in fourth quarter was 1.15 percent, which was primarily due to an income return of 1.01 percent, according to NCREIF.
NCREIF does get a lot of attention from institutional investors. “It is widely viewed as one of the most consistent, transparent and reliable indexes and benchmarks for industry performance,” says Chandan. NCREIF also has a long history of performance data that has been collected and reported over more than four decades across a number of different business cycles. “The references to the NCREIF indexes are so universal amongst institutional investment managers who are either using or contributing to the data, that it is really a part of the fabric of the institutional investment community,” he says.
What is NCREIF?
NCREIF is the National Council of Real Estate Investment Fiduciaries. It is a member-based organization that serves the institutional real estate investment community as a non-partisan collector, validator and aggregator of commercial real estate performance and benchmarking information. It produces a number of indexes, two of its most important indexes are its NCREIF Property Index (NPI) and its Open‐end Diversified Core Equity Index (NFI-ODCE), both of which have existed since the 1970s.
The NPI reflects investment performance for more than 9,200 commercial properties, totaling approximately $700 billion in market value. It focuses specifically on performance of stabilized core assets. The ODCE Index (which industry participants often pronounce as "odyssey") currently consists of 26 funds with a gross asset value of about $270 billion. The ODCE is arguably the more watched and followed of the two now, because it’s viewed as a key indicator of how the private real estate market is doing. “It is extremely important, and most institutional real estate portfolios are now compared to ODCE performance more commonly than they are compared to the NCREIF (NPI) performance,” says Jeb Belford, a managing director at Clarion Partners.
Although both indexes track the core real estate market, one of the differences is that the NPI is an unlevered index whereas the ODCE funds do carry some leverage and most funds do have some small value-add exposure. The ODCE also tends to have a slightly higher total performance, generally because of the leverage and value add components. ODCE funds range in size from the largest at $40 billion in assets to the smallest around $1 billion.
Being listed on the NCREIF ODCE Index is something funds use to their advantage in fundraising as it helps put them on the radar for institutional investors. “In my opinion, if you want to be considered a serious competitor in the core investment world you will want to be in the index. It is important,” says Belford. There are a number of open-end funds that are not in the index, but in most cases, it is because the strategy is a bit different, either higher risk (core+) or property sector specific, he adds. Funds that want to be included on the index do have to apply for inclusion with NCREIF and meet certain criteria, such as adequate diversification and no more than 35 percent leverage.
“From a fundraising perspective, consultants have indicated a preference for core funds to be included in the ODCE index so that there is a clear benchmark with which to measure performance and compliance with the index guidelines around various risk measures,” says Jolly Singh, managing director, portfolio oversight at CIM Group. CIM Group’s open-end core real estate fund was added to the NFI-ODCE in fourth quarter 2020.
Many pension funds benchmark their private real estate portfolio performance against the ODCE index and, in turn, managers in the core space focus on outperforming the ODCE Index, adds Singh. In addition, managers higher up the risk curve focus on outperforming the ODCE Index by a particular spread based on the amount of additional risk they are taking, he says.
Unpacking performance data
NCREIF has provided insights on institutional quality real estate across numerous market cycles, and retail investors also are turning to NCREIF for additional insights. The total return (gross of fees) for the ODCE in 2020 was 1.19 percent, down from 5.34 percent in 2019 and well below the three-year annualized return of 4.92 percent. However, the one-year total return for 2020 was comprised of 3.85 percent income and a -2.59 percent appreciation return, meaning that rents held up reasonably well under the pandemic pressures.
For investors looking to core real estate to diversify and stabilize portfolios, the ODCE index suggests that private real estate may be doing as it is intended. However, those returns also spark questions for some investors. Are returns that are sub-2 percent worth the inherent risks that come with real estate investment? Is now the time to make a contrarian play and buy real estate that may be poised for a rebound as the economy recovers? Or is it time for investors to lower return expectations? The answer to those questions requires peeling back the layers to better understand the NCREIF indexes.
Over the course of a 10-year hold, institutional quality core assets have historically delivered total returns of 7-9 percent. Coming out of the Great Financial Crisis, core assets delivered several years of above average returns of 10-12 percent. So, it is important to look at the snapshot of the 2020 return within that longer term context.
What is unique during the COVID-19 cycle is that the index is a reflection of a blended return across core assets in office, industrial, retail and multifamily sectors, and there is a huge difference between the top and bottom performers. NCREIF noted in its recent webinar discussing fourth quarter results that the gap between the market leader—industrial—and retail on the low side is likely the largest it has been in the history of the index.
“Where the overall index might be a reflection of the space combined, but when you unpack it, it really matters what is happening in different markets and property types. So, what is really determining relative performance more than anything right now is the mix and strategy of the fund,” says Belford.
"Certainly, since 2020 the world has been in the midst of a pandemic, which has broad implications for economies and real estate investment markets," adds Sean Ruhmann, a partner at TA Realty, real estate investment management firm. However, when you dig into the underlying property types, there is a more complicated story. The ODCE index is mainly comprised of office, industrial, multifamily and retail assets. "There was a pretty meaningful divergence in performance across property types last year," he says. Retail in particular did not do well due to sales shifting to e-commerce that accelerated during COVID-19. Conversely, industrial warehouse has done very well. "So, when you look at the index returns, some funds did better or worse depending on their allocations," he adds.
Most investors use that index as a benchmark to judge underlying performance of their investment managers and individual funds where they are invested. “We think of the Index the same way. How are we doing relative to the broad benchmark as a whole, and what decisions do we think we should make that can drive better performance,” he says. Fund managers can use the data to think about the constructs of their portfolios. What locations and property types are going to be attractive for generating attractive future returns? “Where it is helpful from a granular standpoint is thinking about what has happened, and then overlaying that lens of what we think is going to transpire in the future, and how should we adjust our investments accordingly,” he says.
Going forward, fund managers and investment advisors may use the NCREIF index results to make strategic decisions, as well as recalibrate investor expectations. “Over the last several years in the real estate market, our forward-looking expectation of returns has been a little bit more reserved, even prior to the pandemic, which reflects the longevity of the cycle,” says Chandan. “Where any index is going to be extremely helpful for us, and the NCREIF Index in particular because of its reliability and consistency, is being able to provide that benchmark. What is the basis for thinking about what a reasonable set of returns are?” he says.