CRE Outlook 2025: How a Bust Could Become a Boom
Everything you need to know about commercial real estate right now, including where market players see their greatest opportunities in the coming year and when to expect significant improvement in the struggling office sector.
By Matt Doffing, Senior Editor at The Financial Brand
Commercial real estate is one of the most dynamic and challenging markets bankers have navigated in recent years. It’s also a significant part of banks’ lending activity. Research by the Federal Reserve Bank of St. Louis shows that almost 40% of CRE-backed debt is held by U.S. banks. But what does the future hold for it?
Reports from economists and bankers suggest what now feels like a bust is forming into a boom, particularly for specific sectors. To understand the direction of CRE—especially given that the Federal Reserve has finally started reducing interest rates—we digested most of the recent reports on the industry, and we mainly found good news. CRE looks to be turning a corner on its hard times.
The economists and bankers tackled the topic from different angles, some going into more detail than others. But many of the same themes popped up repeatedly, with general agreement apparent on some of the major developing trends.
Below are our biggest takeaways after sorting through reports from Moody’s, Deloitte, Wells Fargo, PNC, and more.
Is the Tide Turning for CRE?
Economists at Wells Fargo think so.
The Federal Reserve’s rate cut of 50 basis points in September — though not a magic bullet — lays the groundwork for a commercial real estate recovery, they wrote in a blog post. They anticipate "a string of rate cuts through the summer of 2025," with those reductions amounting to an additional 175 basis points.
The real estate sector leaders at Deloitte are similarly upbeat. They foresee "a generational opportunity" as the worst CRE downturn since the global financial crisis started to turn the corner.
The Deloitte report draws on insight from a global survey of major commercial real estate owners and investment companies. The survey, which was conducted over the summer, asked 880 C-level executives and their direct reports about their company’s growth prospects in the coming 12 to 18 months, the shifts they anticipate in commercial real estate fundamentals, their investment priorities, and more.
"Our survey respondents have indicated that there has been a positive change in sentiment on the prospects of real estate broadly," the Deloitte team says in its September 23 report. "An increase in revenue growth and transaction activity could soon be at play."
"An increase in revenue growth and transaction activity could soon be at play."
— Deloitte team
Both Deloitte and Wells Fargo caution that there are hurdles ahead. When asked which trends pose the greatest risk of negatively impacting their financial performance, the North American respondents in the Deloitte survey cited elevated interest rates, cost of capital, cyber risk, regional political instability, and changes in tax policies as the top five, in that order. These same factors, in varying order, also rank highly for the respondents from Europe and Asia Pacific.
So why is there such positivity overall?
As the Wells Fargo economists point out, a reduction in interest rates helps ease pressure on a key CRE metric called the cap rate and slows a decline in property valuations. (The cap rate is the ratio of a property’s net operating income to its market value.)
At the same time, the prospects of an economic soft landing appear to be coaxing capital off the sidelines. This bodes well for CRE by making the hurdles that hindered the industry growth less daunting.
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What About All Those Doomsday Warnings on Debt Maturities?
Close to $1.9 trillion of CRE debt is set to mature by the end of 2026, a hefty increase from recent years. CRE lending typically involves balloon-type loans, where most of the principal is due at maturity.
Deloitte, Wells Fargo, and others view this mountain of loan maturities as surmountable. The Wells Fargo economists acknowledge that borrowers who have to refinance in the near term will have challenges, given cap rates, valuations, and relatively tight credit markets. But, they write, "Fed cuts provide a ladder to help clear the debt maturity wall."
Many lenders have been willing to push maturities to a later date, with the expectation that the environment for refinancing will improve. This has helped keep distressed sales from spiking. Wells Fargo cited data from Real Capital Analytics showing that as of September, the share of distressed sales rose to about 3% in 2024, a slight increase from 2% in 2023. For comparison, they pointed out that the share of distressed sales averaged 17% in 2010 after the global financial crisis.
Though the sheer volume of debt that needs to be refinanced could exceed the capital available, economists expect at least some improvement in that imbalance, partly due to monetary policy easing.
Banks are still cautious, but fewer are tightening lending standards. As JPMorgan Chase explains, banks should be able to become more active in CRE as rates decline.
With rates rising as fast as they did in recent years, "cash flow coverages on many deals have gotten skinnier." Al Brooks, the head of commercial real estate at JPMorgan Chase, says in a September blog post. "Commercial real estate lenders have had to take out additional reserves against their portfolios."
But "as interest rates decrease, cash flow coverage increases, bringing down loan loss reserves for banks," Brooks says. "Lower reserves can then be put back into the market and facilitate more deal flow."
In addition, activity from other sources of CRE capital, like life insurance companies, government-sponsored entities, and the commercial mortgage-backed securities market, has picked up, the latter significantly so, driven by hotel, industrial, and healthcare originations, according to Wells Fargo.
"All told, capital flows look to be percolating, a trend which appears likely to continue if the Federal Reserve further reduces interest rates in the year ahead," the Wells Fargo report says.
What Are the Main Takeaways on Specific Sectors of CRE?
There is plenty of caution to go around, particularly regarding office buildings. But based on the reports we reviewed from economists, bankers, CRE firms, and others, most sectors are doing well.
In a PNC blog post, Dan Mullinger, head of real estate for the $557 billion-asset Pittsburgh bank, describes the CRE sectors of retail, industrial, and affordable housing as stable, as detailed in the box below. Mullinger also notes that multifamily real estate, commercial mortgage-backed securities, and even office space are on an upward trajectory. Others largely echo the PNC assessment.
"Even though we’re at a difficult point in the economic cycle, we are seeing businesses start to act to move toward their business goals versus remaining ‘on pause,’" Mullinger says. "That gives us optimism for what’s ahead."
CRE Sector Overview
Stable
Retail: Retail traffic remains steady, including for mall properties. Consumer spending has been relatively strong for most of 2024. If this changes, it would have an impact not only on the retail sector, but the economy as a whole.
Industrial/Logistics: Industrial and warehouse properties have shown resilience. Supply chains are holding up overall, and there is support from reshoring by manufacturing companies and others reconfiguring their supply chain logistics.
Affordable Housing: Elevated construction costs, interest rates, and operating expenses continue to impact the supply of affordable housing across the United States. Despite these challenges, household formation and population growth continue, so investment in this sector remains key.
On an Upward Trajectory
Multifamily Real Estate: A record amount of supply of multifamily real estate is projected to become available in the final few months of 2024. The record absorption level so far suggests high demand for multifamily properties. But the supply is in excess of the demand, with increased rates of vacancies and concessions.
Commercial Mortgage-Backed Securities: One notable trend that has emerged in 2024 is a substantial increase in CMBS activity. CMBS origination slowed down early in the year in anticipation of rate cuts by the Fed, but that changed as months went by without a cut. CMBS loans can be an attractive option in a high-rate environment.
Office Space: A surprising finding from PNC’s June survey of U.S. CFOs points to the possibility of an impending rebound for the office space market. Among the 300 CFOs who participated, 65% expect their companies’ office square footage will increase in the next 12 months, with only 3% expecting a decrease in office space. The remainder expect no change. (The companies spanned 23 industries, 61% of them had more than 1,000 employees, and 31% had revenue of $1 billion or more.)
Source: PNC
In the Deloitte survey, North American respondents ranked multifamily at the top of their list of CRE sectors offering the greatest opportunities over the next 12 to 18 months, followed by logistics/warehousing, industrial/manufacturing, single-family housing, and the digital economy. The latter includes properties such as data centers and cell towers.
So Just How Worrisome Is the Office Sector?
"Office is where the real problem exists," says Elliot Eisenberg, chief economist at the Miami consulting firm GraphsandLaughs and a frequent speaker who aims to make economics fun. Challenges include hybrid and remote work and a rash of layoffs in industries like technology.
The average office vacancy rate in the top U.S. metro areas is at a record high of 20.1%, according to Moody’s. The firm says that the 902 million square feet of vacant space is equivalent to about 300 One World Trade Centers.
But the office sector is so bifurcated that its dynamics vary widely from one city to another, from downtown to suburban areas, and even from one building to the next—with some doing very well.
The primary industries of particular cities often play a role. For example, the recovery in New York and Miami got a substantial boost from the financial companies based there exerting pressure on workers to return to the office, Moody’s says. Meanwhile, San Francisco struggles mightily, partly because of tech workers with flexible work arrangements. Some of those workers have even decamped to less expensive states like Texas.
"In the past, you had a nice building to impress your clients. Now you have a nice building to impress your employees."
— Elliot Eisenberg, GraphsandLaughs
In an analysis of 618 commercial real estate submarkets that Moody’s published in September, San Francisco ranks as the bottom-performing metro. That’s because its office vacancy rate increased 12.2% from 2019 to 2024, climbing to 21%.
Knoxville, Tenn., which had a 2.8% drop in its vacancy rate since 2019, is the top-performing metro. Its vacancies are at 13.4%.
Moody’s found that many metros with comparatively shorter commute times experienced strong office performance rebounds, while car-dependent cities such as Houston and Los Angeles continue to lag. Houston’s office vacancy rate is 25.4%, while Los Angeles is 18.6%.
Property vintages are also a key factor. Newer office buildings, particularly those built after 2010, are seeing much stronger net absorption rates than older buildings.
"If you have to convince your workers to come to the office, you’ve got to have a nice place for them to do the work," Eisenberg says. "In the past, you had a nice building to impress your clients. Now you have a nice building to impress your employees."
Newer buildings are renting for "high, high, high" dollar-per-square-foot prices, he adds. But lower quality "B" and "C" office buildings are becoming obsolete and need to be repurposed or demolished.
Moody’s credits adaptive reuse of older buildings with reducing some existing inventory and helping to prevent more profound office stress. A relative lack of non-owner-occupied new construction projects is also helping.
Moody’s notes that nearly 100% of the new office construction is Class "A," as has been the case for a decade. Developers are focused on building trophy office space with outstanding design and amenities in locations with excellent transportation not just in terms of commuter distance but also between cities.
Moody’s stance in its deep dive on the office sector is positive, suggesting "glimmers of a bottom" are emerging. Still, Moody’s economist Ermengarde Jabir expects six to eight more quarters of feeble office performance before vacancies decline and rent growth improves significantly.
In the interim, bear in mind that selectivity will persist. "People want office buildings," Eisenberg says. "They just want nice ones."
