From Challenge to Opportunity 2025 Commercial Real Estate Outlook

From Challenge to Opportunity: 2025 Commercial Real Estate Outlook

Insights from the Excelsior Capital Acquisitions Team

From Challenge to Opportunity: 2025 Commercial Real Estate Outlook

Insights from the Excelsior Capital Acquisitions Team

As we move into 2025, investors are entering the new year with cautious optimism. While the last two years have presented challenges, there’s a growing sense that opportunities will emerge as the economic environment stabilizes. Below, we share key takeaways from 2024 and explore where the greatest opportunities lie for investors in the year ahead.

The Changing Landscape of Valuation and Debt Markets

Over the past six months, the Federal Reserve has taken decisive steps to address inflation, including a 100 basis point reduction in short-term interest rates. As a result, we’ve seen a reversion in the previously inverted debt curve. During the post-COVID period, long-term debt was cheaper than short-term debt, a result of the Fed’s emergency monetary measures. However, as we move forward, debt markets are returning to more typical relationships, with short-term debt once again being cheaper than long-term debt. This shift represents a return to more “in-tune” debt markets, positioning 2025 as a year of rebalancing for investors.

We anticipate “spreads” — the difference between the coupon attached to the U.S. Treasury rate and the borrowing rate — to narrow in 2025.

This should lead to more attractive investment opportunities, with better valuations for buyers. However, the ongoing higher interest rate environment remains a challenge, and the key to success will be finding opportunities that can withstand this pressure.

Investment Opportunities in a Higher Interest Rate Environment

From an acquisition standpoint, the market is still offering opportunities, but at a slower pace than the highs of two or three years ago. The primary challenge remains identifying deals that “pencil out” in today’s higher interest rate environment or those that can be pursued on an all-cash basis. Successful investments will likely require either a very low acquisition basis or a clear path to significant Net Operating Income (NOI) growth within the first two to three years. Without this, even with lower Loan-to-Value (LTV) ratios, investors will be faced with negative leverage, which can erode returns.

For those able to pursue all-cash acquisitions, the current pricing discounts present an opportunity to preserve capital while positioning for long-term upside. These types of acquisitions are less about immediate cash flow and more about capital preservation and future value appreciation.

Key Trends and Attractive Asset Classes

  • Multifamily and industrial remain the most attractive asset classes for institutional investors, and as such, we are seeing the tightest cap rates within these sectors. In industrial, shallow-bay warehouses are becoming more appealing than bulk industrial space due to higher leasing activity in the sub-100K square foot range. Additionally, Industrial Outdoor Storage (IOS) and Build-to-Rent (BTR) homes have seen the greatest demand growth over the past year – a trend we expect to continue into 2025.
  • One notable factor to watch is the muted pace of new development starts. This slowdown in new supply, particularly in industrial real estate, is expected to have a lagging effect on rents in the next couple of years. As supply tightens, vacancy rates will likely decrease, leading to upward pressure on rental rates.
  • The office sector continues to be challenging, though we’ve seen a slight uptick in leasing activity in recent months. While valuations for office properties are still well off their highs, this recent activity could signal a modest rebound in valuations — a small “bounce” from the lows. However, underwriting office investments will remain difficult, and these deals are likely to be most successful if pursued on an all-cash basis, similar to industrial and multifamily opportunities.

The Path Forward

Despite the challenges of the past few years, the fundamentals of commercial real estate are beginning to stabilize, providing a foundation for renewed investor confidence. The sector’s long-term outlook remains positive, particularly as we move into a more balanced economic environment. As equity inflows and transaction volumes gradually increase, commercial real estate will continue to present opportunities for those with a keen eye on value-add and opportunistic investments.

As 2025 unfolds, we anticipate a resurgence of capital in the sector. Investors will be focused on identifying deals that can outperform in this shifting market, whether through repositioning, value creation, or strategic acquisitions. The market may not be at its peak, but it offers compelling opportunities for those prepared to navigate the evolving real estate investment landscape.

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