Key Real Estate Themes to Watch in 2025

Topics: Capital Markets/Commercial Real Estate

2025 presents an interesting opportunity in commercial real estate (CRE). With a pullback in valuations and expected strong fundamentals going forward, some key themes are emerging...

  1. The long-term trends in macroeconomic conditions of slow growth and a deceleration of inflation rates will continue.
  2. The risk of recession exists, but there is still potential for a soft landing.
  3. A strong probability for lower interest rates remains given the recent 0.25% cut in the federal funds rate at the short end of the curve, planned cuts in December, and slow growth and inflation, which tend to drive the long end of the curve.
  4. CRE returns are down approximately 19% from the peak,1 providing a compelling entry point for high quality assets with solid long-term fundamentals.
  5. We’ve seen several quarters of construction starts fall off significantly across CRE sectors. 2025 is expected to see a good amount of the pandemic-era construction boom absorbed, setting up for strong operating fundamentals.
  6. Debt maturities and distressed owners may need to sell in 2025.

Soft Economy May Stimulate CRE Investment Activity

With the Bureau of Labor Statistics (BLS) estimating employment growth at 0.4% annually through 2033, compared to 1.3% growth from 2013 to 2023,2 the coming years are likely to see real GDP growth weaker than the historical norm. This decline is driven by demographics – the aging population and declining birthrate will not generate many new workers. 2025 will likely continue to fit that mold, with real GDP growth in the 1.25% to 1.75% range with tepid inflation. Typically, economies with this type of aging population and slow GDP growth tend to see disinflation and low interest rates. While this makes for a less dynamic economy overall, CRE tends to perform well in such environments, as lower financing costs drive higher potential leveraged returns, and fewer dynamic investment alternatives exist.

Historical Declines Prove Positive for CRE3

The NCREIF NPI-ODCE index, which tracks the performance of large, private investment funds focused on core real estate properties, has only seen three periods of declines lasting two quarters or more since inception in 1978: the S&L Crisis of the 90’s, the Great Financial Crisis of 2008-2009 and the present pullback. Both pullbacks prior to today’s provided sound CRE entry points, where returns outperformed the long-term average coming out of the distressed period. While we do not yet have confirmation that the present decline has ended, its duration and magnitude, combined with the outlook for lower interest rates, reduced new supply, and continued demand for CRE suggests 2025 may provide a similarly exciting entry point.

IPC NPI ODCE Index Chart 2024-1Source: NCREIF NPI-ODCE Index

Opportunity for Distressed Property Acquisitions

Additionally, 2025 may offer investment opportunities due to debt maturities and distressed equity owners. Many deals were purchased at elevated valuations in 2020 and 2021, driven primarily by extremely low interest rates. The success of these deals was predicated on the cost of capital remaining low and outsized rent growth continuing. With today’s elevated rates and rent growth not meeting expectations, the ability to refinance these assets may be limited, forcing a sale when debt matures. Many of these assets, however, are extremely well located and well built. The distress typically is a result of capital markets and not fundamental weakness in the assets’ ability to generate strong cash flow.

Overall, we believe that commercial real estate buyers with strong balance sheets may see an opportunity to acquire struggling assets in the short term but prove to be a strong long-term investment strategy.

Search for Resilient RE Video Course-2

1 https://www.bloomberg.com/news/articles/2024-09-24/commercial-real-estate-activity-picks-up-with-buyers-lenders-returning

2 https://www.bls.gov/news.release/pdf/ecopro.pdf

3 NCREIF NPI-ODCE Index

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