The last four years have been very challenging for commercial real estate (CRE) owners, developers and investors. And that’s probably understating the matter.
— Cautious optimism in the commercial real estate industry.
— Commercial real estate and the 2025 economy.
— Commercial real estate and the interest rate picture.
— Continuing trends in commercial real estate.
— Commercial real estate investing in 2025: Where to deploy capital.
— Commercial real estate 2025: The takeaways.
Cautious Optimism in the Commercial Real Estate Industry
The first half of 2020 was defined by a global pandemic that kept people out of office buildings, away from shops and retail establishments, and barred from restaurants and entertainment venues. Multifamily (apartment buildings) and industrial (warehouses, trucking terminals, manufacturing facilities, and data centers) fared well during the COVID crisis, but other CRE sectors were devastated.
Perhaps even more consequential than the pandemic itself was what followed in its wake: persistent high inflation, rising interest rates, and a disruptive change in the public’s attitude about renting and patronizing expensive CRE after learning they can, just as easily, work, eat, and be entertained at home.
As the CRE industry and the bankers and brokers who finance them look forward to 2025, there is reason for cautious optimism. The CRE outlook for 2025 is one of increasing clarity, continued stabilization, and ample opportunity for intelligent and agile players.
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Commercial Real Estate and the 2025 Economy
The CRE industry had legitimate fears that high inflation and the subsequent rise in interest rates would derail the U.S. economy. Time will tell if we are indeed out of the woods, but it appears that U.S. Federal Reserve Chair Jerome Powell has avoided recession and engineered the soft landing he was trying to achieve. Monetary policy continues to loosen, we are in the early stages of a rate-cutting cycle, and inflation has eased down to a more reasonable and manageable level. All that is good news for CRE investors, who depend on strong businesses and confident consumers, and who rely heavily on debt to finance their real estate holdings.
That’s not to say the economy will be gangbusters in the year ahead. The Conference Board — the nonprofit research organization behind the Consumer Confidence Index (CCI), the Leading Economic Index (LEI) and other important economic indicators — projects that the U.S. economy will grow at a rate of just 1.7% in 2025. That number is lower than its estimate of 2.7% for 2024. Factors contributing to slower growth projections include an inflation rate that’s still a bit higher than the Fed’s target of 2%, ongoing wars in Europe and the Middle East that are depressing investment, development and commerce in those regions, and lingering uncertainty about the depth and breadth of the Fed’s current rate-cutting campaign.
Still, slow and steady growth is better than no growth, and much better than negative growth which would characterize a recession. CRE investors are mostly happy with the moderate growth predictions, especially considering the alternative. The tax and consulting firm Deloitte & Touche LLP conducts a global CRE outlook survey annually. This year, after two consecutive years of pessimism, about 88% of the 880 CRE executives who responded said that they expect their companies’ revenues to increase in 2025. Roughly 60% are expecting revenue to grow at 5% or more.
Commercial Real Estate and the Interest Rate Picture
As mentioned above, the U.S. has embarked on a rate-cutting cycle. How long that cycle will last and how low rates will get is unknown. Central banks, however, only control certain key interest rates that dictate what they, as quasi-government agencies, charge money center banks to borrow money. The Fed does not directly control rates corporations will pay by issuing bonds or borrowing from the bank. So far in this cycle, a lower Fed funds rate has had only a moderate effect on long-term rates CRE firms pay to finance their operations.
Several factors contribute to the general level of rates. These include the overall economic outlook, inflation expectations, and market factors such as the supply of capital and the demand for loans. These factors, coupled with a red-hot stock market that’s been attracting massive amounts of capital to equities and away from debt, are all converging to keep CRE financing costs higher than investors would like.
Unfortunately, the ongoing “higher for longer” rate scenario is expected to persist into 2025. CRE professionals should not make financing or investing plans based on the hope that borrowing costs will be proportionately correlated with the falling Fed funds rate. Recent history proves that’s not the case. Instead, the CRE industry should take heart in the fact that rates have stopped going up and are off recent highs.
Although the cost of capital is higher than desired, it’s much more manageable than it has been and is heading in the right direction. The CRE industry has no reason to expect dramatic rate shocks that will negatively impact business.
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Continuing Trends in Commercial Real Estate
Several CRE market trends that have been developing over recent years are expected to continue through 2025.
The Impact of E-Commerce
E-commerce, which includes online shopping and aspects of the gig economy, is growing fast. It will become a $7 trillion industry in 2025, according to forecasts, and that could be a low estimate.
The effects on CRE will be dramatic and unmistakable. Industrial real estate classes such as warehouses, distribution centers and trucking terminals should continue to be beneficiaries of this trend. Data centers, call centers and server farms should also benefit.
Work-From-Home and Hybrid Work
Despite the wishes of corporate management, the work-from-home trend still has traction with American workers. A compromise between workers who prefer to stay home and managers who want them in the office is developing in the form of hybrid work, that is, working a predetermined number of days in the office in exchange for the privilege of working home for a day or two each week.
In 2025, these trends will continue to cost the office sector money. Office owners are having to deal with underutilized space and are spending large amounts of money converting traditional offices into smaller, more flexible, hybrid workspaces.
Green Real Estate
Tenants, consumers and government regulators are continuing to demand sustainable buildings and environmentally friendly practices from landlords and property owners. This trend is expensive but is not bad news for real estate investors.
Sustainable buildings built or updated with environmental, social, and governance (ESG) principles in mind are more attractive to the businesses that rent them. This helps building owners attract good tenants and allows them to charge premium rents. Further, an energy-efficient building costs less to heat in the winter and cool in the summer, saving the landlord money over the long run.
Repurposing Brick-and-Mortar Retail
An inevitable effect of the e-commerce trend is the closing of some brick-and-mortar stores that couldn’t adapt to the new digital realities of modern shopping. The result is a lot of unused retail space in prime locations all over the country.
Innovative CRE firms will continue to capitalize on this trend in 2025 by purchasing derelict retail space and repurposing it into things like entertainment venues, flexible office space, pop-up kitchens, multifamily residential units and athletic facilities.
Commercial Real Estate Investing in 2025: Where to Deploy Capital
Each year presents its own set of difficulties and holds its own opportunities for potential reward. While no one can predict the future, the outlook for 2025 is positive for the following five CRE classes.
Multifamily Residential
Demand for quality apartment units with reasonable rents remains very strong. There is no reason to think that this demand will soften significantly in 2025 or anytime in the foreseeable future. Demand is especially high and growing fast near population centers on both coasts of the U.S. and in the Southeast region of the country.
Reasons for the strength of the multifamily sector include a shortage of affordable apartments, lower levels of family formation and single-family home buying among Generation Y and Generation Z as compared to previous generations and robust immigration trends that necessitate decent housing for low and moderate-income families.
Data Centers and the Digital Economy
The e-commerce trend mentioned above is only one factor driving the incredible growth of the digital economy. Others include cloud computing, the rollout of 5G cellular technology, the emergence of artificial intelligence (AI), blockchain and cryptocurrency, app-based payment and credit processing, the Internet of Things, and the growth of the internet in developing nations. All these areas and others — such as self-driving automobile technology — that demand high-speed communication and computing depend on digital infrastructure real estate to function.
Digital infrastructure real estate includes call centers, data centers, server farms, cell phone towers and microchip manufacturing facilities. By all accounts, the need for this class of CRE is well short of the supply. That’s sure to remain true through 2025 and beyond.
Industrial
Closely related to the growth in the digital economy is the growth in demand for industrial properties, including trucking terminals or logistic centers, warehouses, storage, and manufacturing plants.
The American consumer has come to expect instant availability and fast delivery of almost all consumer goods, including staples, discretionary products, groceries and ready-to-eat food. If companies are to fulfill the growing demand, they’re going to need more industrial real estate in more local rather than regional locations. Savvy investors and developers understand that this trend isn’t going to slow down in 2025 or the years ahead.
Senior Housing and Assisted Living
There are several strong market drivers that will make senior housing a good investment in 2025. The U.S. population is an aging population, especially among the baby boom generation, which still number about 64 million people between 61 and 78 years old. Also, advances in medicine and health care technology mean people are living longer today than ever before.
All of this points to a big gap between the current supply and demand of senior housing, nursing homes and assisted living facilities in every part of the country. The high cost of health care and a strict regulatory environment make senior housing a difficult industry, but huge demand growth can make it very profitable for those who succeed in the sector.
Hospitality
In 2025, the hospitality industry is expected to continue the resurgence and solid growth it’s been experiencing for the last 24 months. The opportunity for CRE investors who own or invest in hotels, resorts and short-term recreational rental property should follow suit.
The trend toward travel and recreation is fueled by a strong employment market and a correspondingly strong stock market which both contribute to high consumer confidence. In other words, Americans have money to spend on short trips and long vacations, both of which necessitate hospitality real estate.
Potential CRE investors should keep in mind, however, that the hospitality sector boom is more cyclical and more economically sensitive than the other highlighted trends. The opportunity in hospitality is real and should persist through 2025, but it is not a macroeconomic megatrend like the aging of the baby boomers or the transition to a digital economy.
Commercial Real Estate 2025: The Takeaways
CRE has weathered a challenging era, but the outlook for the near future is more positive than it’s been since the end of the COVID-19 pandemic.
The economy will not set any growth records, but it appears to have avoided a recession and may, in fact, get the soft landing CRE professionals hoped for. This has CRE executives feeling optimistic.
Recently established CRE trends including the growth of the digital economy, the work-from-home trend, the greening of CRE, and the rehabbing and repurposing of retail space will continue.
There are long-term CRE investment opportunities in multifamily, data centers, industrial real estate and senior housing. There is an emerging opportunity in hospitality that should be viable through 2025, but is more cyclical in nature.
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The Commercial Real Estate Outlook for 2025 originally appeared on usnews.com
