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CONTRIBUTORS

Indraneel Karlekar

Global Head of Research & Strategy
Clarion Partners

Approaching an inflection point

The US economy remains well positioned heading into 2025, despite elevated interest rates and heightened geopolitical threats. The labor market continues to exhibit strength and resiliency, inflation is declining, albeit at a slower pace, and the Federal Reserve (Fed) has begun to cut its policy rate, a move that should create positive economic momentum next year.

Commercial real estate, which has been under valuation pressure since the Fed started increasing interest rates, is also poised to be a beneficiary of the central bank’s easing program. For the first time since 2022 Q2, institutional-quality US real estate saw positive returns in 2024 Q3, as reflected in the quarterly NCREIF NPI Index,1 which suggests that we are nearing an inflection point.2 Real estate values are stabilizing, lending markets are easing, construction starts are declining, and a near-record amount of uncommitted dry powder sits on the sidelines. Our base-case expectations are for generally constructive economic growth, and with the presidential election in the rearview mirror and the Fed’s rate-cutting cycle now underway, investor sentiment should improve in 2025, leading to improved capital markets activity.

Structural tailwinds support market fundamentals

Commercial real estate fundamentals appear well positioned across most sectors. Excluding office and life sciences, vacancy rates are generally below long-term average levels and net operating income (NOI) growth remains strong. Tighter lending conditions, elevated building costs and increased return requirements have led to a sharp decline in new construction starts, particularly in the industrial and multifamily sectors, which should bolster near-term rent growth.

Looking ahead, we expect industrial rent growth to outperform given the strong demand for Class A warehouse space, its relatively low vacancy rate, and the steep decline in construction starts in recent quarters.3 The average vacancy rate in the multifamily market appears to be stabilizing at around historical average levels, despite enduring a record wave of completions over the last couple of years.4 With multifamily starts down by roughly 40% from peak levels, vacancies should trend downwards, supporting healthy rent growth as the supply wave eases.5 Neighborhood and community centers construction remains relatively dormant, with quarterly completions in 2024 Q3 totaling the lowest level since 1990.6 As a result, the average availability rate for the sector remains well below historical average levels.7 Additionally, institutional capital and attention continues to shift to the alternative real estate sectors.

Clarion Partners is focused on several investment themes as we move into 2025, including the housing shortage, demographic shifts, innovation, shifting globalization and resiliency.

Looking forward

Clarion Partners is generally optimistic about the commercial real estate environment in 2025. A more accommodative interest-rate environment, improving liquidity, and healthy property fundamentals should produce an attractive window for investors. Potential investment risks include a re-acceleration of inflation, higher-for-longer interest rates, and the threat of a recession. As such, we believe it is prudent for investors to monitor macro developments closely, underwrite new investments conservatively, and deploy capital selectively.

ENDNOTES

  1. The NCREIF Property Index (NPI) is a quarterly, unleveraged composite total return for private commercial real estate properties held for investment purposes. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
  2. Source: NCREIF, 3Q24.
  3. Source: CBRE-EA, 3Q24.
  4. Source: CBRE-EA, 3Q24.
  5. Source: US Census Bureau 3Q24. Analysis by Clarion Partners Investment Research. Note: Calculation based on trailing six-month average start rate as recommended by the US Census to analyze trends in starts.
  6. Source: CBRE-EA, 3Q24.
  7. Source: CBRE-EA, 3Q24.

 

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