Although U.S. commercial real estate is not out of the doldrums, the outlook has turned at least selectively positive.
While some geographical areas remain cyclically challenged, and the office segment is facing a long period of readjustment, the data center and warehouse sectors are particularly strong, as are specialty properties such as medical offices, according to Cris deRitis, deputy chief economist at Moody’s Analytics.
Demand for retail properties has largely recovered, in some cases even exceeding pre-pandemic levels. “There were death spiral stories [about closed-air malls] going around for years with the popularity of online shopping, but now it seems like even those properties are being transformed,” deRitis said. “Retail today is battle-tested, having survived two existential crises.”
Banks significantly scaled back CRE lending after interest rates ramped up in 2022. As the pandemic’s impact subsided, investors in commercial mortgage-backed securities (CMBS) stepped up. They bought $103.6 billion in CMBS securities last year, nearly tripling 2023’s $40.6 billion, according to Trepp.
Multifamily housing has largely returned to a more traditional pattern guided by cyclical supply and demand.
Mark Bhasin, senior vice president of Basis Investment Group and adjunct associate professor at New York University’s Stern School of Business, noted the oversupply of multifamily properties in the Sunbelt stemming from developments initiated in the wake of the pandemic, when people were leaving top-tier gateway markets such as San Francisco for technology and New York for finance, and northern cities more generally.
Mark Bhasin
That migration has since slowed. However, roughly 660,000 units were completed last year, and 445,000 are expected this year, raising multifamily vacancy rates as high as 15% in cities such as Austin, Texas.
“The developments often start in good times when demand is strong and interest rates are low, but they’re delivered into oversupplied markets,” Bhasin said.
Multifamily markets in the Northeast and parts of the Midwest are now in more favorable parts of the market cycle, with tighter inventories and positive rent growth. Freddie Mac’s 2025 Multifamily Outlook revealed inventory ratios – the number of units delivered during the prior 12 months compared with the overall multifamily inventory – under 2% and rent growth above 2% for the Northeast and Midwest as of 2024’s third quarter. Those are similar to first-quarter 2024 numbers.
In the Sunbelt, from the Carolinas to New Mexico, the third-quarter inventory ratio was 4.3%, up from 3.7% in the first quarter, and rent growth was negative 2.6% versus 2.2%.
Some factors, meanwhile, are bolstering Sunbelt markets, such as the semiconductor production in Phoenix that continues to fuel its housing market.
“We’re not expecting any of these markets to outperform like in the pandemic because of the interest-rate environment, but we don’t expect a crash either, because of the strong tailwinds,” deRitis said.
Quarterly and annual multifamily demand, from the Freddie Mac 2025 Multifamily Outlook.
West Coast multifamily inventory was low, at 1.3% in the third quarter, yet rent growth was barely positive, according to Freddie Mac. The effect of the 2025 wildfires in the Los Angeles area on property markets remains to be seen. California multifamily otherwise remains relatively strong, deRitis said, with the exception of San Francisco. Its office vacancies at around 35%, compared to a pre-pandemic 5%, are a significant drag on multifamily and retail.
Office CRE remains problematic, especially in major urban areas where vacancies today of 20% to 25% compare to 10% before the pandemic, Bhasin said, “And that’s all driven by Class A, B and C office space.”
An exception is relatively new Class A trophy properties in prime locations offering sought-after amenities. Brandywine Global portfolio manager Tracy Chen pointed to recovery in the office CMBS new-issue market. However, the deals are primarily securitizing revenue streams of trophy properties in single asset, single borrower (SASB) transactions.
“In 2023, investors didn’t want even those,” Chen noted. “In the last year, SASB office CMBS new-issue bonds have had tighter spreads and been oversubscribed multiple times.”
According to Trepp, SASB issuance in 2024 was nearly triple that of CMBS conduit deals. Those securitize as many as 100 CRE loans, typically not for trophy properties.
Class A “commodity” office space, especially in prime locations, is better off than Class B and Class C, but all are struggling to find tenants, deRitis said. That increases refinancing risk, exacerbated by significantly higher interest rates than when many of the loans were originated.
“That’s a key risk factor and a reason, I believe, that we won’t see much improvement in the office sector overall this year,” the Moody’s Analytics economist said. “Continued trouble lies ahead in terms of defaults and foreclosures for the weaker Class B and Class C properties.”
Real estate risk remains in the sights of the Federal Reserve Board, which included in its 2025 stress-test scenario “a collapse in asset prices, including about a 33% decline in house prices and a 30% decline in commercial real estate prices.”
“High exposure to commercial real estate” is one of the “watch list indicators” of bank stress in an analysis published by the Federal Reserve Bank of Dallas on March 4. The report’s overall conclusion is that bank stress has declined over the two years since Silicon Valley Bank and other large regionals failed and will continue to do so as interest rates normalize.
Banks were flagged for high commercial real estate concentration risk if the ratio of non-owner-occupied commercial real estate and construction and land development loans to the sum of Tier 1 capital and the allowance for credit losses exceeded 600%; or the ratio of construction and land development loans to the sum of Tier 1 capital and allowance for credit losses exceeded 125%.
Trepp recorded rising delinquencies across CRE CMBS sectors in 2024, but office rose the most. In December, the office delinquency rate topped 11%, exceeding the 2012 high water mark of 10.7%. Trepp estimates $36 billion in office maturities are coming due in 2025, primarily in the first half, chief product officer Lonnie Hendry said in a webinar.
“We could easily see office delinquencies hitting 12% to 14% over the next couple of quarters,” he said.
Amplifying the risk is that many CMBS pay interest-only for some or all of their terms, and thus must refinance most if not all of the principal. Along with higher rates and reduced tenant income, many borrowers face “maturity distress,” which Trepp defines as the inability to refinance an existing loan with six months to maturity.
“In January 2022, about 40% of delinquency was due to maturity distress; now it’s 75%,” Trepp’s senior manager of research, Thomas Taylor, said in the webinar.
Sales of office properties, especially the non-trophy variety, have been slow, so valuations are cloudy. They increased 20% in 2024 over 2023, to $63.6 billion, according to MSCI. That’s well below the $142.9 billion average per year from 2015 through 2019.
“While the return of investors should help cushion the blow, it's too small to dramatically change the trajectory of the market,” deRitis said.
In part, that’s because borrowers have been waiting for interest rates to fall; in the meantime, their lenders have offered extensions or other loan modifications to avoid taking losses. That dynamic may change as high rates linger.
DeRitis observed that banks don’t want to rush to foreclose on loans in their portfolios, but they are increasingly likely to do so given the ongoing cost to carry underwater loans, and most institutions are sufficiently capitalized to absorb the losses.