Has springtime arrived for commercial real estate?

Commercial real estate (CRE)—which is composed of multi-family, industrial, hospitality, retail, and smaller niches like life sciences, self-storage, student and senior housing—has been a headline topic since the onset of COVID-19, a 5% increase in base interest rates, and a regional banking crisis that delivered a perfect storm for weakening property valuations.

After two years on the back foot, we believe commercial real estate has found a floor and is exhibiting a nascent recovery in early 2025. While the macroeconomic backdrop remains uncertain, we see potential upside in resetting valuations, transaction volumes, and capital availability trends.

Setting the stage: Slowing activity, lower valuations and a wide performance range

Since 2022, many public and private commercial real estate-backed obligations, which were underwritten in years of ultra-low interest rates, were no longer viable at higher rates and lower property valuations. On average, CRE values fell by about 21.6% peak to trough from 1Q22 to 4Q23 according to the Green Street Commercial Property Price Index (CPPI).¹ Generally, multi-family, industrial/warehouse, and data center sub-sectors were resilient while retail, hospitality, and office faced challenges per Green Street. U.S. office properties experienced a 37% decline on average from 2019 to 2024,² with “trophy properties” faring much better than those exposed to rising vacancies, demographic shifts, hybrid work trends, and/or more dated styles with less attractive amenities.

Exhibit 1: Commercial real estate prices are down and may have found a bottom

February 2020 through February 2025. Source: Green Street

In the debt market, commercial mortgage-backed securities (CMBS) also exhibited a wide performance range across factors including property type/asset mix, origination period, and the degree of exposure to credit risk. In our opinion, this provided a good backdrop for experienced credit pickers who could identify attractive valuation opportunities, though we thought it was too early to add risk broadly in commercial real estate.

In 2022, private market activity slowed, creating difficulty in determining accurate pricing. This trend continued in 2023 as dollar volumes of global real estate transactions declined by 36% year over year to $1.2 trillion.³ Per The Wall Street Journal, "total global real-estate fundraising by private-equity firms that invest in real estate was $10 billion in the fourth quarter of 2024, a five-year low, according to data firm Preqin.”⁴ Borrowers stood on the sidelines, hoping rates would normalize, while banks and alternative lenders backed away to address their existing portfolios. Lenders hoped to delay painful write-offs by getting loan amendments and extensions. In public markets, CMBS issuance ground to a standstill in 2023 despite a looming maturity wall that needed to be addressed.

Budding reasons for optimism in a stabilizing market

The upside is that commercial real estate, including office, managed to avoid a broad distressed cycle and has entered 2025 on stronger footing with sentiment, transaction volumes, and valuations showing early signs of progress. The CPPI advanced by 4.5% year over year as of February 2025 according to Green Street.¹ Deloitte's 2025 Commercial Real Estate Outlook surveyed global CRE professionals and found over 68% of respondents expected improving CRE fundamentals in 2025 including cost of capital, capital availability, leasing activity, rental growth, and vacancies (compared to just 27% in the prior year's survey).³

Per The Wall Street Journal, CRE "is showing signs of recovery so far this year. Debt markets have improved with the issuance of commercial mortgage-backed securities up nearly threefold in 2024, compared with 2023. Sales activity has also picked up, giving the market more clarity on property values." ⁴ Further signs of a market thaw include the renewed issuance of CMBS bonds backed solely by office properties. According to J.P. Morgan, nearly $12 billion of office-backed CMBS deals have been met by sufficient investor demand since 4Q24, though these were all for “trophy properties” and challenges remain for other asset types.⁵

An opportunity to capitalize on valuations and capital needs

We view the current potential investment opportunity as twofold:

• First, we believe public CMBS valuations have improved but continue to offer appealing valuations versus the sector's own history and corporate bonds. Credit spreads—that is, the extra compensation that investors receive for assuming the credit risk inherent in bonds—remain wide for CMBS versus history, whereas corporate bonds entered 2025 priced for perfection, in our opinion.
• Second, within private markets, we believe there may be a structural opportunity to partly replace bank lending with private capital. Per Deloitte, "bank lending will likely still be more subdued compared to prior levels as they manage exposure to the sector amid regulatory scrutiny." ³ Blackstone recently raised $8 billion for a commercial property debt fund, its largest ever in the space.⁴ Other asset managers with CRE experience have echoed the view that CRE may provide an attractive bank disintermediation trade—that is, an opportunity for capital providers and borrowers to bypass banks to work directly with each other to structure deals. We will monitor this potential secular trend as it develops. In the meantime, we believe there is an attractive tactical opportunity owing to a supply/demand imbalance in asset-backed lending markets.

Active management: A necessity for navigating the risks

An increase in distress and defaults is likely in our opinion as some loans, which were underwritten in a time of near-zero interest rates, are untenable in current economic conditions. However, the consensus view of many CRE specialist managers is that market distress will be idiosyncratic rather than broad-based. As a result, we believe active management is crucial in the sector to distinguish the winners from the losers. Credit stress appears contained in early 2025, but bears watching, as 5% of non-agency CMBS loans are 90 days or more past due, downgrades have outpaced upgrades, and defaults may tick up as the industry works through the maturity wall.⁵

Finally, commercial real estate is sensitive to changes in economic growth, unemployment, and interest rates. We believe the current bout of tariff-driven uncertainty will temper or delay some of the recent improvements in the commercial real estate market. Economic uncertainty may increase risk premia broadly, which would be positive for lenders. CMBS may experience mark-to-market volatility, but we think the market will distinguish between commercial real estate winners and losers once the dust settles. Still, public securities have a relatively attractive entry point, in our opinion, and private lenders will likely benefit from the ongoing imbalance between the supply and demand of capital in this space.

 

 

 

1. Green Street | Commercial Property Price Index
2. CommercialEdge National Office Report | February 2025
3. Deloitte 2025 Commercial Real Estate Outlook
4. The Wall Street Journal | March 7, 2025
5. J.P. Morgan Fixed Income Weekly as of February 28, 2025