The closing months of 2024 were marked by significant events — including a presidential election, Federal Reserve rate cuts, and shifting economic trends. These developments set the stage for a transformative year in commercial real estate (CRE).
Experts are optimistic about the new administration’s policies, which are expected to bolster demand for real estate. However, concerns about potential tariffs affecting retail contrast with the possibility of increased industrial development due to heightened demand for domestic manufacturing. Economists suggest that the positive momentum could create a self-fulfilling cycle of growth.
Many businesses can now plan and execute strategies with greater certainty, which is crucial for investors developing long-term plans. “CRE investors need to feel comfortable in the stability of the short- to mid-term outlook in the overall economy and capital market to make investment decisions,” says Eric Paulsen, President of Brokerage at Kidder Mathews. “We just need to know the rules of the game to play. Once investors are comfortable with the swim lanes or guide rails, transactions will increase.”
The overall economy remains robust, with consumer spending and strong labor demand providing tailwinds. However, several economic and lending factors will shape the CRE landscape in 2025. Kidder Mathews’ Brad Kraus, EVP in Century City, adds that uncertainty still lingers in the capital markets. “The broad array of policy initiatives proposed by the incoming administration has prompted Treasury traders to shift from longer-dated maturities, such as 5- to 30-year Treasurys, to shorter duration maturities. Holding long-term Treasurys in this environment presents significant downside risk. Compounded by the growing national debt, even the sharpest economists have an unclear picture on the true cost of capital moving into the future ” Kraus explains.
Interest Rate Cuts and Transaction Activity
The Federal Reserve delivered three consecutive interest rate cuts from September to mid-December 2024, and those reductions have largely been warmly received by the commercial real estate sector. However, the long-awaited reduction in the base rate has unexpectedly been countered with headwinds. Long-term commercial borrowing rates rose, and a shift in the 10-Year Treasury yields has kept the brakes on deal flow. “The recent volatility in Treasury yields has left buyers, sellers, and lenders uncertain. Many deals are stalled since locking in elevated rates for 10-year money simply doesn’t make financial sense right now,” says Kraus.
The Federal Funds rate directly influences short-term borrowing costs, encouraging spending and investment. Still, the broader economic factors driving the 10-year Treasury yield, such as inflation expectations and global demand for U.S. debt, have led to rising long-term rates. Before the first rate cut in September, the 10-Year Treasury yield stood at 3.64%; by mid-December, it had climbed to nearly 4.60%. This increase has made long-term debt financing more expensive, slowing deal flow and complicating development plans.
“Bridge lending and floating rate loans have provided some relief, especially for value-add projects, where lower costs and flexible underwriting criteria can keep deals moving while waiting for fixed-rate terms to stabilize,” adds Kraus. Investors who anticipated a surge in activity following rate cuts adopted a “wait-and-see” approach due to these higher borrowing costs. While optimism is growing as uncertainty recedes, sustained confidence among investors and developers hinges on further stabilization of long-term rates.
Negative Impact of Extend-and-Pretend Strategies
CRE loan distress is a reality that regional U.S. banks are facing that bears a watchful eye in 2025. This practice, known as “extend-and-pretend,” certainly raises concerns because some believe it amounts to a systemic delay in acknowledging the issue. The Federal Reserve Bank of New York notes that this practice could lead to broader financial instability in the banking sector if left unaddressed.
“While monetary defaults are a concern, it’s worth noting that many loans remain current on payments. Strong fundamentals often justify loan extensions, even when DSCR and LTV covenants are in violation — a practice that with some smoke and mirrors can get a thumbs up from bank regulators,” says Kraus.
The extension of loan terms may address the immediate issue but also may conceal distress, since regional banks are not actually recognizing troubled loans. There’s roughly $400 billion in near-term CRE loan maturities, which increases the potential for systemic risks and could exacerbate financial risks. That wall of maturity now accounts for roughly 27% of bank capital, which is significantly higher than the 16% reported in 2020. Additionally, the situation is likely limiting banks’ capacity to issue new loans.
Multifamily Sector Gains Momentum
While investor confidence in office, retail, and industrial sectors has waned, multifamily is gaining ground. According to Altus Group’s Q3 2024 U.S. CRE Survey, 69% of investors expect multifamily to outperform other sectors due to limited housing supply and barriers to single-family homeownership. On a transactional basis, multifamily transactions remain about 35% below pre-pandemic levels.
Sun Belt markets like Phoenix, Dallas, and Atlanta saw a 20% increase in multifamily completions in 2024, with absorption rates exceeding 90%. Meanwhile, slower-construction regions like the Northeast and Midwest reported occupancy rates as high as 95%. Multifamily demand continues to grow as more potential homebuyers are priced out of the market, reflected in a 13% year-over-year decline in home sales.
Research by the National Multifamily Housing Council showed improvements in multifamily sales, equity, and debt financing, with all indices above 50 in October 2024. Debt availability increased due to a 28-point drop in the 10-year Treasury yield and Fed rate cuts. Equity financing also reached its most favorable level in more than two years.
NMHC’s Market Tightness Index in October came in at 37 — below the breakeven level of 50 — indicating looser market conditions for the ninth consecutive quarter. While nearly half of survey respondents (46%) thought market conditions were unchanged relative to three months previously, 40% thought markets have become looser, up from 27% in July. Fifteen percent of respondents reported tighter markets.
The NMHC Sales Volume Index reading of 67 reflected a third straight quarter of increasing deal flow. As was the case the previous quarter, the plurality of respondents (46%) reported sales volume to be unchanged from three months ago in October. Forty-three percent reported higher sales volume in the October reading, increasing from 21% in April and 32% in July, while 10% thought volume was lower. The NMHC survey firmly reflected both increasing sales volume and more favorable financing conditions.
2025 Market Drivers
A resurgence in CRE transaction volume began in mid-2024 and has continued into the fourth quarter, signaling promise for the year ahead. As short-term rates decrease, development and value-add projects are expected to become more viable. Additionally, equity investors with real estate allocation requirements are likely to inject significant capital into the market. “While capital for transactions is abundant, the main challenge is aligning deals with the appropriate risk-adjusted returns. A clearer economic outlook is essential to bridge the buyer-seller gap and establish a stable market floor,” explains Kraus.
Market dynamics indicate a shift in sentiment: The prolonged low-rate environment is no longer expected to return, and volatility in bond markets is pressuring investors to address upside-down deals. This could lead to an increase in asset sales as property owners adjust their strategies.
Market fundamentals remain the best gauge for activity, transcending inflationary pressures and rate fluctuations. Dislocation in the market may create attractive buying opportunities, particularly in growth markets, allowing savvy investors to acquire assets at favorable valuations with potential for outsized returns.
As the gap between buyers and sellers narrows, transactional activity will help establish pricing benchmarks, boosting confidence among lenders, buyers, and sellers alike. With optimism driven by rate cuts and a new administration, 2025 is poised to be a pivotal year of growth and recovery for the CRE industry.
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