After years of persistent inflation, rising interest rates and shifting tenant needs, commercial real estate (CRE) property owners and investors are feeling cautiously optimistic about the year ahead. A combination of lower interest rates, evolving tax policies and improving market dynamics is expected to drive an upturn in the sector.
Still, challenges and uncertainties remain, tempering expectations and projections. A record number of CRE loans maturing between 2024 and 2027 continues to put refinancing pressure on property owners, investors and financial institutions. In addition, proposed regulatory and trade policies add complexity to the industry’s outlook.
Key Trends Influencing the Commercial Real Estate Landscape
Stabilizing Interest Rates
The Federal Reserve cut interest rates three times in 2024, indicating reduced concerns about inflation; however, interest rates are expected to remain higher for longer. Additionally, 2025 will see a slowdown in rate cuts unless the economy falters. For highly leveraged properties, expect some difficulties with refinancing as banks struggle with regulatory restrictions and treasury returns.
The 10-year Treasury yield, another important driver for CRE mortgage rates, is predicted to be in the 3.8% to 6% range for 2025. The 10-year rate is expected to remain in the mid-4% range throughout 2025. With net interest costs accounting for 19% of federal receipts in 2025, long-term lending pressures may persist even if the Fed continues to cut rates.
The combination of interest rates, cap rates, bid-ask spreads, and liquidity will impact deal flow in 2025. Look for 2025 deal flow to be similar to 2024 in most CRE categories. However, some acceleration of deals could easily occur in second half of 2025 with accelerating rent growth in the categories.
Tax Changes and Extensions
Without Congressional action, significant tax breaks are set to sunset (or continue to phase out) at the end of 2025 under the Tax Cuts and Jobs Act (TCJA). Nobody knows for sure, but with a real estate-friendly administration, expect to see some favorable tax policy changes in 2025. CRE property owners and investors are tracking legislative discussions about extending key provisions, including:
- Bonus Depreciation: The depreciation rates are slated to decrease from 60% in 2024 to 20% in 2026. There is bipartisan support in Congress to restore 100% bonus depreciation, which is designed to incentivize investment in property improvements and development.
- Qualified Business Deduction (QBI): The 20% QBI deduction is set to expire at the end of 2025, increasing taxable business income. Extending the deduction has support, but it’s expensive. As a result, modifications to the deduction are on the table.
- The State and Local Tax (SALT) Deduction Cap: If the $10,000 cap is allowed to expire after 2025, CRE investors in high-tax states could benefit. However, the expiration would also significantly impact federal tax revenues, so discussions around extending or modifying the cap are underway.
An Evolving Commercial Real Estate Market
Demand for commercial office space continues to evolve as tenants redefine their space requirements. Office property vacancy rates held steady at 19% in the second half of 2024, following nine consecutive quarters of increasing vacancies. Reflecting a significant reduction in new office construction, office vacancy rates are projected to peak in 2025, with higher vacancy rates in lower-quality office buildings, as occupancy in Class A buildings remains relatively stable.
Cap rates for most property types are expected to be steady throughout 2025. Multifamily vacancy is high in several markets, with added supply in the last few years. However, with immigration, absorption and cost to own being high, there may be compression in cap rates as rent growth accelerates in the second half of 2025.
In response to vacancy rates and lower property values, office conversions to multifamily residential, life sciences and industrial use continue to increase. Many cities, including New York City, Chicago and Washington D.C., offer incentives and tax breaks for conversions to address rising demand and market shortages.
Niche markets, such as senior housing, and alternative property types, such as the surging demand for data centers, are emerging industry opportunities in the years ahead.
Construction Costs and Workforce Challenges
A record number of new multifamily units came to market in 2024, with an estimated 2 million units expected by 2028. Data centers, warehouses and hotels are also projected for construction growth in 2025. However, investor optimism is tempered by cost and labor concerns.
Construction labor shortages continue to be a challenge, with 90% of contractors reporting difficulties in filling hourly and salaried positions. In addition, proposed tariffs pose potential cost increases and supply chain issues for materials and supplies.
Risk Management and Mitigation
Property and casualty insurance premiums for commercial properties have increased in recent years, driven by inflation, higher construction costs and increasing catastrophic weather events. CRE property owners and investors can expect the trend to continue in 2025. Through the first 10 months of 2024, there were 24 weather disaster events with losses exceeding $1 billion each.
Taking a strategic approach to mitigating risks helps to optimize protection, reduce costs and address evolving regulatory requirements. Regular risk assessments identify vulnerabilities, evaluate risk exposure and pinpoint opportunities to improve risk management across a CRE firm’s property portfolio.
Proactive investment in sustainability-focused initiatives can help reduce physical, regulatory and economic risks and increase property value. Cities and states continue to implement and enhance regulatory requirements for green building practices, building performance standards and energy efficiency benchmarks, creating both incentive opportunities and compliance complexity for CRE firms.
The dedicated commercial real estate experts at CBIZ assist CRE property owners and investors in evaluating market opportunities, navigating tax and financial strategies, and managing risk. Connect with a member of our team and gain access to more resources here.
This article includes input from Ed Hanley, a Managing Director of CBIZ, with more than 30 years of experience in public accounting. Ed provides tax services, business advice and strategic consulting to privately held companies and their owners.
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