Responding to cooling inflation and a resilient labor market, the Federal Reserve initiated a long-anticipated rate-cutting cycle in late 2024, potentially reducing rates by 1.5 to 2% over the next 24 months, an action that should help financing deals in commercial real estate (CRE) sector.
A Historical View
Office CRE has experienced several cycles of booms and busts but has historically demonstrated resilience following economic contractions and usually begins to rebound within two years of a slump. For example, after the downturn in the late 1990s, during the savings and loan crisis, it took about 20 months for office properties to regain full value, while recovery following the 2000s downturn (the dot-com bust) took approximately 38 months, according to Fitch Ratings.
While the Great Recession didn’t officially end until June 2009, office failed to return to its pre-recession peak until the second quarter of 2011 — 3.5 years after the initial onset. The current downturn has persisted for over two years and is the longest since 2009.
The pressing question now is: how quickly will it take for the sector to respond and fully recover?
The pressing question now is: how quickly will it take for the sector to respond and fully recover?
The Road to Office Recovery
The consoling factor in today’s market is that we’ve seen similar economic cycles before. Although the current post-pandemic situation has had its own nuances, there’s precedence for an inevitable recovery.
“Looking back at various downturns in economic cycles, you’ll note the predictable fleeing from various asset classes that followed,” says Marc DeLuca, KBS CEO and regional president, Eastern U.S. “But whether it was the overbuilding in the ’90s and the financial crisis, the dot-com bust, or 9/11, time after time, those classes of commercial real estate ultimately came back — sometimes in roaring fashion.”
What makes the current downturn and subsequent office recovery challenging is that some industry experts see the office market’s broader recovery being much slower and more protracted than preceding cycles.
What makes the current downturn and subsequent office recovery challenging is that some industry experts see the office market’s broader recovery being much slower and more protracted than preceding cycles.
According to the September 18, 2024, Summary of Economic Projections (SEP) from the Fed’s Federal Open Market Committee (FOMC), the federal interest rate is projected to decrease over the next few years.
“Assuming we’re near or at the bottom of the office CRE cycle, the office investment landscape is poised for a recovery that will present new opportunities ahead,” said Robert Durand, executive vice president of finance at KBS. “Amid the recent and expected future rate reductions, the dry powder waiting on the sideline should start to seek out strategic CRE investments, including office space, next year.”
Here we take a look through 2027 and beyond, highlighting the potential effects rates may have on commercial real estate as they change:
2025
By the midpoint of 2025, the office sector may begin to gain momentum. According to a Resume Builder survey, 87% of companies will return to an office by 2025. This, in addition to the lower cost of doing business that rate cuts typically provide, is likely to jump start office leasing activity. It’s also anticipated that there will be continued improvement in leasing activity at higher quality office assets.
On the financing side, 2025 should see a significant uptick in refinancing and other transactions, fueled in part by non-bank lenders. According to S&P Global, nearly $1 trillion of CRE mortgages will mature in 2025 and increase every year thereafter until it peaks in 2027 at $1.26 trillion. About 8 to 10% of those maturities are office. Typically, once interest rates reach the mid-3% range, which is expected in 2025, the refinancing opportunities should improve considerably.
Banks are likely to see some office loan payoffs starting in 2025, which will provide banks with increased liquidity to capitalize on positive market trends and open them up to investment opportunities in CRE. There was a rise in commercial mortgage-backed securities (CMBS) financing activity in 2024, which is being carried into 2025. Overall, rising CMBS loan activity is a positive sign for the office sector and may be a beacon of broader economic trends.
Life insurance companies should also begin to show increased appetite for commercial mortgages, particularly in favored property types like multi-family and industrial.
Moreover, lower rates in 2025 may help owners of lower- quality or obsolete office properties free up some capital to upgrade buildings and amenities to compete with in- demand top-tier assets.
Moreover, lower rates in 2025 may help owners of lower-quality or obsolete office properties free up some capital to upgrade buildings and amenities to compete with in-demand, top-tier assets.
“With the sector near or at the bottom of the cycle, many investors may find value-added investment opportunities at reasonable prices,” said Durand. “However, with pricing potentially stabilizing in the near future, buyers looking for the best deals will
need to move quickly and may not find as many bargains as they might expect, especially in best-
in-class office assets.”
2026
The Fed forecasts that interest rates will begin to stabilize by 2026, providing greater clarity on the economy’s trajectory and the office sector’s role within it, potentially sparking a new growth cycle
for office CRE. It’s been estimated that there’s about $382 billion globally of dry powder sitting
on the sidelines, suggesting that CRE and office may be on the verge of a growth cycle.
On the development side, several years of higher interest rates, an extremely challenging construction loan market, supply chain issues and inflation have stalled — if not outright prevented — most new construction.
2027 and Beyond
Compared to 2025 and 2026, the year 2027 is poised to experience greater refinancing activity as CRE loans are typically refinanced after 5, 7, or 10 years. Loans originated in 2022 at higher interest rates could be refinanced at more favorable rates, creating opportunities for borrowers.
On the acquisition front, if rates stay low, more investment money should move into the office playing field, especially for well-located and highly-amenitized quality assets.
While lower rates provide a modest, yet welcome tailwind, a long-term perspective is still important — as is a focus on property fundamentals such as location, demand, and local economics.
According to Deloitte’s 2025 CRE outlook, CRE’s office sector has reason to be optimistic, with 88% of industry leaders expecting revenue growth in 2025. But it’s important to remember that recovery tends to be a marathon, not a sprint.
It is essential for the office sector to remain strategic and disciplined, positioning itself to capitalize on emerging opportunities over the next two to three years. Although lower rates offer a modest but welcome tailwind, maintaining a long-term perspective remains essential, alongside prioritizing property fundamentals such as location, demand, and local economic factors.
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