Investors Line Up to Make $20B in Core Property Fund Withdrawals

Institutional investors lined up in Q4 for an estimated $20B in withdrawals from core real estate equity funds, according to IDR Investment Management, which tracks an index of open-end diversified core equity (ODCE) funds holding an estimated $350B in assets.

In a stampede last seen during the Great Recession in 2009, institutional investors have rushed to limit their exposure to a bevy of big-ticket core equity funds managed by JPMorgan Chase, Morgan Stanley and Prudential Financial, among others, as property values decline, Bloomberg reported.

IDR’s index of ODCE funds—known as NCREIF—dropped 5% in December. The redemption rush is prompting some core funds to attempt to sell their most liquid assets, amplifying headwinds, even in the most resilient CRE sectors, the report said.

The queue for the exits at core funds began to grow in Q3 2022, when UBS Trumbull Property Fund reported that it had more than $7B in pending withdrawals, or about 40% of the firm’s net worth, Bloomberg reported.

Similar to the Dow Jones Industrial Average for stocks, the ODCE index measures how core CRE sectors—office, multifamily, retail and industrial—are performing on average, based on the historical and current returns of the selected open-end funds. The ODCE index is considered a lagging indicator because core funds generally move slower in revaluing assets and are less volatile than REITs.

While the rising cost of debt pounded publicly traded real estate investment trusts, causing an overall 29% drop in returns in 2022, ODCE funds managed to post an overall 7.5% gain in 2022, according to preliminary data released this month by the National Council of Real Estate Investment Fiduciaries.

The ODCE index posted a 19% return in 2021, following a 2.1% result during the nadir of the pandemic in 2020.

According Prequin’s November 2022 investor survey, 74% of investors believe real estate assets are overvalued, with fund managers saying they expect property valuations to fall, GlobeSt. reported.  According to Green Street’s index, the rising cost of borrowing pushed commercial property prices down by 13% last year.

Noting the lag in the ODCE indicator, Garrett Zdolshek, IDR’s chief investment officer urged investors to remember that the outflow queue for ODCE withdrawals in the Great Recession did an about-face quickly after that downturn bottomed out.

“We saw a 15% redemption queue in 2009 reverse to a 14% entrance queue at the end of 2010,” Zdolshek told Bloomberg, adding that while investors are reducing exposure to ODCE funds, they generally are not abandoning entire stakes in these funds.

Analysts attribute the rush for withdrawals at core funds in part to what is known as the “denominator effect,” which refers the amount of a portfolio invested in real estate compared to the overall value of the portfolio—a ratio that has tilted sharply towards real estate as stock and bond holdings tapered while real estate assets appreciated.

According to a recent survey by Hodes Weill, 32% of institutional investors considered their portfolios –encompassing an estimated $11 trillion in assets—to be “over-allocated” to real estate in 2022, compared to 8.7% in 2021.

Unlike funds aimed at “retail” investors—a.k.a. wealthy individuals—ODCE funds don’t specify quarterly limits on withdrawals. Open-end literally means the investor can enter or exit the funds at any time.

Two funds that have quarterly and monthly withdrawal limits–Blackstone Real Estate Income Trust and Starwood—both notified investors last month that their redemptions would be limited because the withdrawal levels had been breached.

Blackstone, which limited withdrawals to 43% of requests in November and even less in December, then received a $4B infusion in liquidity from the University of California.