It’s tough to view a strong economy as bad news. Yet a firmly positive economic projection in ULI’s Real Estate Economic Forecast does not bode well for commercial real estate participants who are hoping for relief in rate cuts from the U.S. Federal Reserve.
“Financial conditions have eased dramatically, and for the Fed to cut substantially would be pouring gasoline on the fire,” says Ken Rosen, chairman of Rosen Consulting Group. “Everyone in this room wants it to happen, for obvious reasons, but the overall economy, I don’t think [that] would benefit from creating even easier financial conditions.” Rosen was one of three panelists discussing the results of the Real Estate Economic Forecast on April 10 at ULI’s Spring Meeting in New York City.
From left to right: moderator Ron Insana, contributor and senior analyst with CNBC; Paula Campbell Roberts, managing director and chief investment strategist for global wealth, KKR; Dr. Ken Rosen, chairman, the Rosen Consulting Group; Mark Grinis, Americas real estate, hospitality, and construction leader, EY, speaking at the ULI Spring Meeting in New York.
The survey results indicate that, although the overall economy is strong, the real estate industry will continue to be challenged by high-interest rates, putting downward pressure on valuations and returns during the remainder of 2024. Although the forecast for individual property sectors varies, the trend lines generally are pointing to more positive growth in 2025 and 2026, with office clearly lagging other property types.
A key focus of the report, which is based on the median of forecasts from 39 economists and analysts at 34 leading real estate organizations, is the ripple effects of higher interest rates. Survey results show that interest rates could be near their peak, with a slow and steady decline ahead to 4.0 percent this year, 3.75 percent in 2025, and 3.63 percent in 2026. However, panelists took a more pessimistic view of the “higher for longer” interest rate environment, with the added backdrop that the CPI data released just before the discussion came in hotter than expected, pushing the 10-year Treasury to 4.5 percent. The March CPI rose 0.4 percent, putting the 12-month inflation rate at 3.5 percent—still well above the Fed’s 2 percent target.
“We believe that we’re actually going to be in a structurally higher inflation environment for quite some time,” says Paula Campbell Roberts, managing director, chief investment strategist for global wealth at KKR. “There are structural forces that I think keep us in this train where we’re just going to have much more inflation volatility.” Those forces include investment in energy transition, geopolitical competition, persistent labor shortages, and AI that is driving demand for both people and power.
Another inflationary force to add to that list is the federal deficit, notes Rosen. The United States is running a deficit of roughly $1.7 trillion, and governments throughout history have inflated their way out of too much deficit. Rosen’s base forecast is inflation at 3.5 percent, which is likely to affect the Fed’s willingness to reduce interest rates, thus setting the stage for interest rates staying higher for longer. Rosen also was quick to remind industry participants that current interest rates of 4.5 percent are still “reasonable” by historical standards.
Transaction volume poised for improvement
Although still weak, transaction volume is expected to begin climbing from a low of $378 billion recorded in 2023, according to MSCI Real Assets. The ULI forecast predicts that transactions will gradually notch higher to $610 billion in 2026.
Even in a higher rate environment, the improvement in transaction volume is achievable, though volume might not rise as steeply in 2025 as the forecast predicts, notes Roberts. One of the big factors that muted transaction activity last year was uncertainty. “That part of the puzzle, at least, is solved,” she says. “No one believes we’re headed higher from here.” The question remains, however, as to when, or if, rate cuts will occur, as well as the ongoing price discovery happening in the market.
Price discovery and a reset in property values are expected to help thaw activity in the transaction market. “We haven’t had a market clearing price yet for the excess commercial real estate that’s out there,” notes Mark Grinis, Americas real estate, hospitality & construction leader at EY. Based on the MSCI Commercial Property Price Index, the ULI Forecast projects that valuations will hit bottom in 2024, falling another 5.0 percent this year before reversing course with value gains of 2.0 percent in 2025 and a bigger bump of 4.0 percent in 2026.
Yet this picture of “gloom and doom” in commercial real estate is exaggerated, says Grinis. According to Trepp, CMBS delinquencies are at 4.7 percent overall, which is half what it was during the Great Financial Crisis. With roughly $800 billion in maturities coming to the market, most of them probably will be paid off or extended. “There’s going to be distress; I just would be hesitant to say it’s a flood, but there will be opportunities,” he says.
Many investors are hoping to capitalize on the opportunities ahead. “I look at this investment environment [as being] like the early ’90s. It’s going to be the best single vintage of investments in 2024 and 2025 as price expectations are reset and the market resets,” Rosen says. The challenge, even with the lower prices, is the negative leverage. “But I do think this is going to be a great investment environment, and the volumes will go up as people capitulate, and they capitulate through selling, or they may capitulate through a foreclosure or other things,” he notes.
Retail fundamentals shine
Retail has made an impressive turnaround from a down-and-out sector to one that has taken a lead position for its strong fundamentals. That success story is largely due to limited new construction, and to owners that have successfully backfilled vacancies with a more diverse variety of tenants ranging from medical office to entertainment.
Retail properties are anticipated to yield the highest returns over the three-year forecast period, averaging 4.6 percent annually. Although industrial and apartments are experiencing some near-term softening due to an influx of new supply, both are projected to continue to post positive returns. Industrial and apartment properties are forecast to have average annual returns of 3.3 percent and 3.2 percent, respectively. Not surprisingly, economists predict ongoing difficulties for the office sector, with an expected average annual return of less than 1.9 percent until 2026.
Office is continuing to struggle with hybrid work models that have pushed vacancies in some metros in excess of 20 percent. The ULI Forecast predicts that vacancies will rise another 150 basis points during the next two years before a slight improvement in 2026. In addition, office rents are projected to contract by an average of 1.1 percent annually during the next three years.
“There’s a survey out there that says by 2026 everyone is going to be back in the office,” Grinis says. “As much as we would like to think that would be nice, as real estate folks, that’s not going to happen.” The reality is that 80-plus percent of people want the flexibility of being able to work remotely, at least part of the time, and surveys have shown that a high number—45 percent—have said they are willing to quit if they don’t get it, he says. So, he adds, the solution for office is probably going to require time for supply and demand to fall back into equilibrium.
It is difficult to paint the entire commercial real estate industry with a single brush. Investors are finding opportunities by taking a more micro view of different property sectors and geographic markets. In multifamily, for example, there’s a lot of talk about oversupply and depressed rent growth in many markets. On the other side of the coin, there are examples such as Boston, which is still producing 10 to 15 percent increases in rent.
“This will be a transition year overall for real estate, but I don’t think that means sit on the sidelines,” Roberts says. “You don’t want to wait until everyone gets the joke about the opportunities in real estate.” It’s important to have local market expertise and be able to pivot to different asset classes and markets where there are opportunities to acquire an asset at a discount to replacement cost, she adds.
Interactive graphic support by Nicholas Stoll.
