A dour mood has consumed the commercial real estate (CRE) market for the better part of the past two years, brought on by a sharp rise in interest rates that prompted prognostications of a market meltdown. Reality has turned out to be much more nuanced, as the market has leaned on the strength of property fundamentals. With investors coming to terms with higher rates and the economic outlook more optimistic, market sentiment appears to be inflecting upward—though the implications of this shift are less straightforward.
Key takeaways
- The CRE market began 2024 as it finished the previous year—with activity muted and property values declining modestly. Property fundamentals broadly remain strong.
- Despite challenges, market sentiment appears to be improving—a positive development.
- We expect activity to improve as the year progresses, but property values may not follow.
The start of 2024 featured a continuation of the slow journey back to normalcy for the U.S. CRE market, as property values remained under pressure and a recovery in deal volume elusive. While Q1 is reliably the lightest quarter for activity in any given year, sales volume of $40.5 billion over the first two months of this year represents a -33% decline from the same period last year. Property values fell -0.56% YTD through February, continuing last year’s trend of more gradual price declines (with the notable exception of the office sector, where prices fell more sharply). On the face, the data appear to show a CRE market that remains stuck in a low gear as a result of the challenges posed by much higher financing costs.1
Even if the data on activity and property values leave us lacking for clear signs of material changes in market dynamics, there does appear to be a shift in sentiment occurring beneath the surface, with market participants becoming more sanguine on the outlook. This has as much to do with what has not occurred in the market over the past two-plus years as it does with what has. The market has undoubtedly fallen on hard times, but predictions of a CRE collapse have turned out to be exaggerated. While talk of real estate–driven financial contagion has made for fine fodder in the financial press, the reality has been less dramatic and more nuanced. As we consider what a potential improvement in CRE market sentiment means, we attempt to answer three key questions core to the CRE outlook: First, how has the market avoided a deeper downturn? Second, why does sentiment appear to be improving? And finally, what do the answers to those questions mean for investing in CRE?
