Commercial Real Estate Market Recovery Underway After Sharp 2023 Correction

What's New

iCapital's Alternatives Decoded Q1 2025 report reveals commercial real estate is showing clear signs of recovery after experiencing a significant price correction through 2023. Transaction volumes are increasing, cap rates have stabilized after resetting higher, and most property sectors are demonstrating solid fundamentals with the notable exception of office space.

Why It Matters

Commercial real estate represents a massive $20.6 trillion asset class in the U.S. alone, with substantial capital continuing to flow in through private equity real estate funds approaching $3 trillion in assets under management. The sector's performance directly impacts institutional investors, pension funds, and increasingly high-net-worth individuals as they seek income and inflation protection.

Big Picture Drivers

Demographics: Nearly 50% of all commercial buildings in the U.S. are over 45 years old, creating significant value-add opportunities through renovation and modernization that can improve NOI.
Supply-demand: Most real estate sectors (apartments, retail, industrial) show healthy supply-demand dynamics with low vacancy rates, while office properties continue struggling with high vacancies now exceeding one-fifth of total space.
Interest rates: Cap rates reset significantly higher as the Fed raised interest rates, with the spread between cap rates and 10-year Treasury yields compressing, although they remain positive.
Financing: Banks have retrenched from commercial real estate lending amid rising defaults, particularly in the office sector, creating opportunities for private credit debt funds that have raised record amounts of capital.
Affordability: The surge in mortgage costs has made multifamily housing relatively more attractive as the percentage of income needed for rent remains lower than that for mortgage payments.

By The Numbers

Property prices: Commercial real estate values fell 11.5% overall from their 2022 peak, with office (-24.1%) and apartment (-19.2%) sectors hit hardest, while industrial properties gained 5.7%.
Transaction volumes: Activity is recovering after steep declines in 2022-2023, providing better price discovery and liquidity for the market.
Vacancy rates: Office vacancies surged to over 20%, while all other property types maintain healthy occupancy levels.
NOI growth: While slowing from recent highs, net operating income growth across property types (except office) remains positive and generally above inflation.
Returns: Private core real estate has historically delivered better risk-adjusted returns than public REITs with less frequent drawdowns, outperforming a traditional 60/40 portfolio over 20 years.

Key Trends to Watch

Distress opportunities are emerging particularly in office properties, where CMBS loan delinquency rates are rising sharply while other sector defaults remain in check.
Value-add renovation spending is projected to increase significantly in coming years, addressing the aging building stock and helping improve NOI through modernization.
Private credit is stepping in to fill the lending void as banks pull back, with real estate debt funds amassing record AUM and dry powder.
Capital market activity recovery in both debt and equity markets should support increased transaction volumes and improved price discovery through 2025.

The Wrap

Commercial real estate markets are showing clear signs of stabilization and recovery heading into 2025, with most property sectors demonstrating resilient fundamentals despite the significant price correction. Strategic opportunities exist in both value-add renovation projects to improve aging properties and in distressed situations, particularly in the office sector where structural challenges persist.