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Leveraging the ODCE Index to Understand Real Estate Valuations

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While many Americans cringed when they look at the returns of their investment and retirement accounts so far for this year, real estate fund managers and investors hoped for a brighter start to 2022. 

The Open End Diversified Core Equity (ODCE) Index, released quarterly, will showcase whether or not the real estate industry’s recovery is still thriving. Founded in 1977 and still administered by the ​​National Council of Real Estate Investment Fiduciaries (NCREIF), the ODCE Index measures how the core real estate market, made up of the office, multifamily, retail, and industrial sectors, is performing on average. The index measures the historical and current returns of 38 open-end real estate equity funds, meaning investors can enter or exit the funds at any time. All funds represented in the index have 95 percent of their total assets in the United States, and 75 percent of those assets are stabilized, a.k.a. leased.

Similar to how the Dow Jones Industrial Index or the S&P 500 are used when analyzing the performance of index funds, the ODCE Index serves as an important metric for fund managers and investors to understand how their real estate assets are performing as an investment vehicle. In 2021, the index held a 19 percent rate of return for the year in comparison to a 2.1 percent return in 2020. That is a far less gloomy picture than what industry chatter foreshadowed last year. 

The data from the first quarter of 2022 was released recently. “If you want to get a sense of how real estate is performing as an asset class versus a fixed income or equities, the ODCE index would be the leading benchmark in the US market. It’s factual in terms of what level of returns have been delivered to date,” said Phil Tily, Senior Vice President at Altus Group and a longtime analyst of the ODCE Index. Each quarter Tily and Altus Group analyzes the ODCE Index’s performance to identify the driving factor behind its performance as a whole and within individual markets and types of real estate.

“If you want to get a sense of how real estate is performing as an asset class versus a fixed income or equities, the ODCE index would be the leading benchmark in the US market. It’s factual in terms of what level of returns have been delivered to date.”

Occupancy vs. value

Real estate as an investment vehicle has never been a short-term game. However, the volatility caused by the pandemic and now other geopolitical events dared investors to make rash decisions.

During the pandemic, for example, the ODCE Index showed that the office property type, while at the bottom end of the performance order, only had values contract approximately 2.5 percent in 2020 and 2021. This shrinkage is far less dire than what news headlines about the future of the office and foot traffic in urban centers may have led the industry to believe. 

The index is based on valuations, which, like funds in the stock market, are independently determined and meant to reflect what those properties would “trade at.” In terms of the office market during the pandemic, these valuations accounted for the actual cash flow structure of the properties. Tily explained that even though offices were primarily empty, “AAA credit-rated tenants were still locked into 10-year leases, and they were paying their rent. From an owner’s standpoint, they’re still getting the income through the door. The ghost towns that some buildings became may be more of a short-term concern from a valuation perspective.”

Returns aren’t built off of transaction prices. Instead, they are professionally valued quarterly to give a sense of the market value for a particular asset. 

“AAA credit-rated tenants were still locked into 10-year leases, and they were paying their rent. From an owner’s standpoint, they’re still getting the income through the door. The ghost towns that some buildings became may be more of a short-term concern from a valuation perspective.”

Putting the index in context 

The real power of the ODCE Index is realized when layered with additional context. This helps investors and portfolio managers alike gain better intelligence about how returns are delivered and why portfolio and individual building valuations may differ from the benchmarks provided by the index itself. 

Referring back to the stock market analogy, the news may talk about returns of a particular index fund or an individual stock, but they often don’t share what drove these returns and what could impact future performance. You may know if the Dow Jones trends upwards or plummets to the red on a given day, but what’s causing that change? Does a specific type of stock drive it? Did geopolitical concerns cause investors to sell? Did the Fed make an interest rate change? The behavior of the stock market paints an incomplete picture. But Tily and the team at Altus Group provide this level of insight by digging into the raw data the ODCE Index provides to identify trends and anomalies and then investigate what’s causing them to move to specific cities and types of real estate.

For individual portfolios, this intelligence on top of the ODCE Index enables managers to assess how a portfolio performed versus the average in the index. Does the portfolio have different sector allocations and is therefore not benefiting from high-performing real estate subsectors like self-storage or industrial warehouses? Are assets in the portfolio located in underperforming cities or even specific neighborhoods? And at the most fundamental level of real estate, are assets in less or more desirable locations?

In addition, mobility, population, and transportation data give fund managers and investors a better understanding of which markets are on the up or downswing. These are just a few of the 200+ hyperlocal economic and demographic data sets that Altus Group layers on top of the ODCE Index from its StratoDem dataset to provide deeper analysis. Mobility data has been particularly interesting as people continue migrating out of major cities like New York and San Francisco into secondary markets such as those in the Sunbelt. Employment diversification is another important indicator of market performance. Those markets with less reliance on one industry, such as tech or banking, have seen more robust office valuations. 

Tily sums up the value of having this additional context, “These broader macroeconomic factors will create a heatmap of opportunities that might exist for portfolio and fund managers. When you layer on city planning and real estate development data, you get a sense of which markets and product types are over or undersupplied to direct future decisions.”

Beyond knowing how these factors and others like them are influencing portfolio values today, this intelligence empowers fund managers and investors to make decisions about how to make their portfolios more valuable in the future, whether that’s through sale, acquisition, or how they position themselves as a more valuable asset from a fund perspective.

Altus Group’s analysis of the ODCE Index for the first quarter of 2022 was released recently, and analysts like Tily are encouraged that apartment and industrial sectors continue their strong performance, even if recovery has eased slightly since the end of last year. The ODCE index showed a gradual improvement in returns for the retail sector, although offices have moved no further forward from a returns standpoint. Overall, investor demand remains strong. In the short run, there might be uncertainty, given concerns about inflation and rising interest rates. Still, there are plenty of reasons to be optimistic about commercial real estate performance as a whole.

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