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AlternativesFebruary 3, 2025

Is the Commercial Real Estate Tide Turning?

Investors have taken a beating on their CRE exposures, but analysts say the worst might be over, giving disciplined investors opportunities at attractive entry points.

By Bailey McCann

Art by Melinda Beck

When investors were looking to start off the year with new allocations, commercial real estate was unlikely to be at the top of that list. However, it might be time to take a second look.

Analysts say that while it will still take time for sectors like office space to fully normalize, other areas, including multi-family housing, senior living and industrial, are starting to pick back up. Private credit firms that offer real estate financing are also seeing an uptick in transactions, which could create new opportunities for investors to diversify their private credit exposures.

“It’s no newsflash to anyone that it’s been pretty brutal to be an equity holder of real estate over the past few years,” says Troy Gayeski, the chief market strategist at FS Investments. “But many sectors have bottomed out, so we are entering into a new period of rebuilding our base. If you’re looking at the asset class from that point of view and maintain discipline about where you are investing and what your underwriting criteria are, there are attractive entry points right now.”

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Rebuilding is not just happening at the investment level. Julie Ingersoll, CIO for Americas direct real estate strategies at the CBRE Group, says she is seeing more institutional investors take stock of their manager relationships and use this moment to decide which firms they think are going to be able to successfully navigate current and future markets.

“A lot of this comes down to how folks were managing their redemption queues over the past few years,” she says. “If investors were getting in and out of the queue in a reasonable period of time, that goes a long way toward maintaining the relationship. But if you’ve got investors that are in the queue and have been there for a long time, it becomes harder for those folks to consider new commitments now that the market is starting to come back. I think we’re going to see some movement in manager relationships over the next year or so.”

Shifting Focus

Alongside changes in manager relationships, investors are also rethinking where they want to put their capital. Data centers have been a big story—especially over the past year—but they are also a big risk. Ingersoll notes that the investment basis to build a new data center can be quite high and, given recent extreme weather events, there is a bigger focus on insurance costs, asset risk and the overall development plan of the area surrounding any data center project. While they may have long-term value, she says it is important to understand the potential risks of any investment.

“As a real estate executive, I’ve never worked more with my infrastructure colleagues than I have in the past few years,” Ingersoll says. “If you look at some of these assets—data centers, cell towers, specialized manufacturing—you have to ask: Is it real estate or is it infrastructure? Sometimes it’s both. Sometimes it comes down to what specific aspect you own. Are you just the four walls of the data center? Or are you doing something more where you need to understand what the access roads look like or what the power generation needs are? All of those factors can impact investment decisions.”

Gayeski adds that it is also important to be discerning when certain sub-sectors start to attract capital from a range of different sources.

“Given recent market action, I wouldn’t be surprised to see some folks get the heebie-jeebies about existing investments in data centers,” Gayeski says. “Generally, as lenders, when we start to see spreads getting as tight as they are around a certain type of investment, we’re going to take a step back and [ask], ‘OK, does this make sense right now?’ It can be very risky to chase hot dots in real estate.”

Some investors are moving into areas like multi-family housing, student housing and senior living. Douglas Lyons, managing principal at Pearlmark Real Estate LLC,says they are seeing heightened demand across all of these areas.

“When we look at multi-family, there are some areas where we have oversupply, but that is likely to work itself out relatively quickly. We still have broad demand nationally because our total housing stock is underbuilt,” Lyons explains. “That’s a tailwind for investors because we anticipate the returns there are going to be solid over the long term.”

Lauro Ferroni, head of capital markets research for the Americas at Jones Lang LaSalle IP, agrees. The cost of homeownership continues to rise, and that is creating new dynamics within the housing rental market.

“Nationwide, the cost of owning a home is about 60% higher than renting, after you factor in rising insurance rates, property taxes and maintenance costs,” Ferroni says. “So we are seeing more people who are saying, ‘OK, maybe renting makes more sense for me,’ but they run into new challenges there, amid housing affordability issues due to our national housing under supply.”

Ferroni adds that construction loans are starting to pick up, but the overall cost of capital and the cost of building materials are still high, which limits how much new construction will be built in the near and medium term.

“Right now, the market favors acquiring existing assets, and until that changes, we expect the construction pipeline will remain subdued,” he says.

Private Credit

Sources say institutional investors are also taking a closer look at gaining portfolio exposure to the commercial sector real estate through real estate financing. Lyons says commercial real estate as an asset class is capital intensive by its nature, but adds that lenders are starting to shift their approach.

“We’re having more conversations about recapitalizations, [and] we’re seeing less of a willingness to extend and amend” loans, Lyons says. “So that could lead to new joint ventures coming in to take over assets. We might see more sales. Everyone is taking a closer look at the fundamentals of the assets they have exposure to.”

Lyons expects to see more activity from private credit, especially in the middle market, because traditional banks are less willing to do deals between $5 and $50 million, the range in which Pearlmark typically invests.

“Historically, banks have had 50% market share, but they’re staying on the sidelines, and that creates opportunities for private credit to come in and provide those solutions, which is a positive for private credit investors,” he says.

Lyons notes that these investments can match up, in terms of risk profile, with other private credit investments while acting as a source of diversification within a private credit allocation.

“If you can invest in a multi-family deal with a 70% to 75% loan-to-value [ratio], you can capture an interest rate on the whole loan that is in the 7% to 8% range, which is really attractive from a returns standpoint.”

Ferroni agrees. He notes that those returns have been relatively consistent and can also be a diversifier in a credit portfolio.

“We’re seeing a lot of capital from institutional investors and sovereign wealth funds flow into the credit side,” he says. “There’s a sense that the returns are more stable [than direct property investments], especially if you’re in the senior part of the capital stack.”

Commercial Real Estate: Is 2025 Going to Be Different?

Economic growth, improving real estate fundamentals could drive a moderate recovery in real estate investment activity.

By Debbie Carlson

Art by Melinda Beck

Elevated interest rates, inflation, a shift in where people work and an uneven global economic recovery battered the commercial real estate market for the past few years, but the sector could see a moderate recovery in investment activity in 2025 as inflation eases and some global central banks loosen monetary policy.

Pedro Guazo, representative of the secretary-general for the investment of the $95.3 billion United Nations Joint Staff Pension Fund, says the fund is “cautiously optimistic” for 2025.

“The question we ask internally is, ‘Did the trendline reverse?’ rather than, ‘Is this the absolute bottom?’” Guazo said in an email. “In that respect, we believe we are near the cycle’s bottom.”

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But, like everything in real estate, location matters.

Institutional investors and managers see selective opportunities in the U.S., Australia, the U.K. and Europe, but China’s markets are still considered too risky for 2025. While location matters, so do sectors. Overall, traditional office real estate remains overvalued, as the work-from-home phenomenon continues to reshape work life, investors and managers say, but non-traditional real estate, such as housing and data centers, appeals.

Unlike previous real estate cycles, some managers are weighing climate change impacts and insurance costs in their calculations as the combination of higher property values and more unpredictable and destructive natural disasters will affect long-term values.

For investors still wary of real estate, Bert Crouch, head of North America at Invesco Real Estate, suggests now may be the time to start looking, especially for those seeking an alternative to equities. After recent weakness, the asset class is under-owned and, in the U.S., he says the market has broadly bottomed. According to Crouch, in the five-year periods after 2001’s dot-com bubble and following the global financial crisis in 2009, investors who bought real estate saw unlevered returns in the low to mid teens.

“Simply put, you’ve been rewarded for leaning in early,” he says.

Invesco’s Crouch also points to opportunities in real estate lending by private credit investors as attractive. It’s still his top idea for 2025 for real estate, across sectors. “I would rather lend than buy,” he says.

He says most loans Invesco makes have 65% loan-to-value ratios on high-quality real estate. Invesco can lend at rates about 250 to 300 basis points greater than the secured overnight financing rate of 4.3%, giving a yield of about 7%. Using some leverage, that yield can rise to 12%, he adds.

Certain Housing Areas Attract Interest

In many countries, housing demand outstrips supply, as demographics shift and lifestyle preferences evolve, making housing a compelling choice for investors and managers. Immigration and household growth increase demand, while higher interest rates make mortgages costly, forcing would-be buyers to rent. Investors see opportunities in multi-family housing, single-family rentals, student housing and senior living.

Jeroen Beimer, head of research at the 16-billion-euro ($16.68 billion) manager Bouwinvest Real Estate Investors, which manages real estate portfolios for Dutch and international institutional clients, says 2024 yielded strong rental growth that he expects to continue.

“If you can find places where there will be substantial rental growth, that’s where we expect in the coming two or three years that these markets will outperform,” he says.

Among the top locations for rental growth are apartments and single-family housing in the U.S. Sun Belt states, which continue to see migration of workers and businesses, Beimer says. Guazo agrees, noting that the U.N.’s Joint Staff Pension Fund is targeting the same sectors. He says 70% of the portfolio is anchored in the U.S.

Beimer says he sees tailwinds in growing metro areas in Canada and Australia, but also some large cities such as Singapore, Tokyo and Osaka, Japan. In North America, he sees student housing and senior housing as other strong sectors.

Stephen Hayes, head of global property securities for Sydney-based $157 billion manager First Sentier Investors, points to opportunities in Australia, including land-lease communities—which often cater to people age 55 and older—offering returns (based on implied capitalization rates) of 5.8% and self-storage facilities, which have an implied cap rate of 7.3%.

Guazo also likes Australia’s prospects, particularly student housing, while in Japan, he says there are “compelling” multi-family opportunities.

Data Centers Grow in Multiple Markets

Data centers also remain attractive, according to most sources. Guazo says the U.N. fund has been investing in the sector since 2017 and has expanded its exposure globally.

“Demand driven by AI is unprecedented, with growth in data consumption significantly exceeding even our most optimistic expectations,” he says.

Even in Europe, where many real estate markets are sluggish, data center growth is a highlight. Hayes points to demand in cities such as Paris and Frankfurt, Germany, and data centers are quickly expanding across Spain, with implied cap rates of 9%.

The slowing economy in the U.K. has opened rare opportunities in London, Hayes says, particularly in publicly traded real estate in London’s West End. Prices are down there because of macroeconomic headwinds stemming from the government’s new fiscal budgets, which raised the national living wage and drove business costs higher. General valuations in London’s West End have an implied 6.1% cap rate.

“Looking through that noise, we see over the next five to 10 years, some very good returns to be had, given the implied valuation,” Hayes says, adding that London’s West End is “just such a unique real estate market, it really can’t be replicated. And the implied valuations, we think are just extremely appealing.”

The logistics market, which includes warehouses, has been attractive for a while due to the boom of online shopping, but Beimer and Hayes suggest that supply is catching up with demand. Hayes is cautious about logistics in an era when the U.S. intends to impose tariffs on imports.

“Some markets will do fine, and others will be impacted by tariffs, and it’ll be pretty tough,” Hayes says. “So it’s not looking extremely appealing to us.”

Insurance Costs to Rise

Rising insurance costs will have long-term implications for returns. Climate-change-driven natural disasters are becoming more unpredictable, and more high-value real estate is being built in areas that have increased risk for natural disasters, driving up costs.

Bouwinvest’s Beimer says that even if a property is not at a particularly increased risk for climate change impacts, higher insurance costs could still be a factor.

“If you are in investing in real estate, and the real estate insurance costs are too high … then it’s affecting the real estate markets in a second-order effect,” he says. “Maybe in the longer term, the second-order effects might be having a larger impact than we now anticipate.”

Hayes concurs. He is less concerned about the individual impacts of specific natural disasters, because of his portfolio’s diversification, than he is about the broader insurance costs.

“We need to factor in those increases in costs, which are likely to continue to be quite material over time, and try and get an understanding of what that’s going to do to operating margins and valuations,” he says.