Outlook 2025: US real estate to take off after economic soft landing?

There is now a virtual universal consensus amongst economists. The US has successfully navigated a soft landing and its growth outlook is the brightest of all the G7 economies. In December, the OECD published a forecast of 2.4% GDP growth for the US in 2025, versus 1.3% for the eurozone and just 0.7% for Germany. Some even suggest it is an underestimate.

In addition to this strong economic background, there is arguably an improved political backdrop for US commercial real estate. As Carey Heyman, managing principal of the real estate industry at consultancy CLA says, “there is optimism that the Trump administration and policymakers will enact policy that would strengthen capital flows into real estate”. He says the potential extension of the Tax Cuts & Jobs Act and the opportunity zone programme, as well as increased federal spending, are likely to further boost GDP growth, “benefiting commercial real estate and rent growth”.

US commercial real estate turned a corner in 2024, as prices stabilised and fundamentals strengthened. Yields are now at their highest in a decade and attractive relative to fixed income and listed equities. Todd Henderson, co-global head of real estate at DWS, notes: “Construction starts have dropped 70% (averaging across sectors) since mid-2022, which will inevitably lead to very low levels of supply over the next two to three years. Coupled with a growing economy and good structural demand drivers, this should underpin strong rent growth.”

The recovery will “gather momentum in 2025” due to these factors, Henderson says. “Rising rents will drive prices higher. They could increase even faster if interest rates continue to decline.”

The Federal Reserve reduced the benchmark rate from 4.5% to 4.25% on December 20, but signalled a slower pace of cuts in 2025 than previously anticipated.

“In our view, with supply evaporating, underlying demand will be the key driver of performance in 2025 and beyond,” Henderson says.

Healthy economic growth, steady unemployment, moderating inflation and limited fears of a recession mean US economic conditions are look solid and bode well for commercial real estate. But Edward Pierzak, senior vice president of research at listed real estate association Nareit, warns: “The market appears to be stuck in a period of stagnation characterised by supply-and-demand imbalances, softening fundamentals, a lingering public-private real estate valuation problem and muted property transaction activity.”

In an outlook report for US real estate investment trusts (REITs), he asserts that “the lingering public-private real estate valuation problem has impeded significant property transaction activity”. The rate-hiking cycle has been marked by the wide and persistent valuation divergence between REITs and private real estate, as REIT valuations adjusted to reflect higher interest rates in 2022, while private valuations moved more slowly. Nareit’s data show that the cap-rate spread between private real estate and REITs fell from 212bps at the end of the fourth quarter in 2023 to just 69bps at the end of the third quarter in 2024.

“As public and private real estate values become more in sync, there likely will be a revival in the currently stalled [commercial real estate] transaction market,” says Pierzak. “REITs’ disciplined balance sheets and ready access to capital – through debt, equity and other forms of financing such as joint ventures with large institutional investors – will provide an important advantage in the current market. Though bank financing for real estate is improving, it remains challenging. With private real estate capital raising in the doldrums, REITs are well positioned to enter a growth cycle.”

And while private real estate fund managers have been struggling to raise capital recently, REITs can call on a range capital sources, including equity, debt and joint-venture partnerships.

What to do with the office?

Then there is the matter of a huge amount of existing real estate debt that will need refinancing. Tony Davidow, senior alternatives investment strategist at Franklin Templeton, says: “There is a wall of debt that will need to be refinanced in the next several years, and banks will likely remain reticent to lend capital, creating opportunities for credit managers who can negotiate favourable terms and covenants.”

This will be a particularly acute in the office sector. Floating-rate borrowers have been under considerable pressure for two years, and while they are eagerly awaiting relief from the Fed to stave off further defaults, interest rates may not fall fast enough.

Chris Hentemann, managing partner and CIO at 400 Capital Management, says: “The Fed will act slowly. We do not expect any meaningful improvement in office fundamentals, as the extensive costs to retain and replace tenant lease expirations weigh heavy on valuations.”

Debt is “the wildcard heading into 2025”, says Chad Lavender, president of capital markets for North America at Newmark. “With $2trn of US office debt maturing by the end of 2026, cities like San Francisco, Seattle and Boston are facing high turnover rates. Over 40% of office properties in these markets may struggle to secure financing.”

US offices have been in meltdown for some time. Will 2025 be the year the sector stages a recovery? Bulls argue that it could evolve in the same way as US retail, which is a sector now clearly back in play. Donald Hall, global head of research at Nuveen Real Estate, says: “Retail benefits from having gone through its price correction early and having limited new supply over an extended period.” He now favours the sector, citing “strong fundamentals, sticky demand, and less competition from other investors”.

Could offices do the same? “Across the US, we’re seeing clear signs of progress, with a renewed focus on urban cores, conversion projects and the recapitalisation of assets overburdened by debt,” says Lavender. “2025 is the litmus test… as the industry shifts from the pandemic reset to forward-looking strategies.”

Office pricing appears to have fallen well below replacement cost and higher cap rates are arguably opening up good entry points for new investment. In a recent real estate outlook report, David Roberts, head of real estate strategy at Macquarie Asset Management, says: “Specific asset and submarket strategies will be key to future performance, with returns remaining tight for new developments, at least in the near term.”

One such strategy could be converting offices to residential. Lavender notes “a nearly four times increase in office-to-residential and other conversions in the next two years” – although it should be noted that such projects only account for only 1.7% of US office inventory.

“The beleaguered office sector is stabilising, but its recovery will be more protracted,” concludes Henderson.

The real growth may come elsewhere

The strong US economic outlook offers further support for established growth sectors. Hall notes: “Data centres are benefitting from a near-insatiable demand for compute power, while industrial continues to look strong globally, particularly smaller light industrial properties in the US.”

One sector might actually benefit from interest rates coming down slowly. “With home loan interest rates and housing prices remaining elevated, we see continued tailwinds for the rental housing market,” says Jacob Feingold, managing director and head of originations at Canyon Partners Real Estate. “While the industry has been concerned over a significant wave of supply, markets have seen strong absorption, setting up 2025 to be a year where owners are finally able to return to going on the offensive.”

Indeed, the US housing market is experiencing an “accessibility crisis” according to Chris Avallone, head of investment management at Amherst. “Millennials, the largest demographic cohort [at 72 million] are reaching their household formation years and are in need of three-to-four-bedroom homes in good communities with good schools.”

According to Newmark, annual demand exceeded supply in 48 of the top 50 US markets and Lavender believes that, “nationwide, we’re short four to seven million homes, with New York City needing 500,000 units by 2032 and San Francisco 82,000 by 2031”.

The “accessibility crisis” creates other opportunities. One out of every nine homes now built in America is a manufactured home, and there are 43,000 of these communities across the country. Michael Levy, CEO at Crow Holdings, says: “Manufactured housing is a compelling investment sector… based on the fractured ownership of the asset class, the housing affordability challenges many people face and the opportunity to add value to these communities.”