As the Federal Reserve maintains a higher-for-longer interest rate stance, real estate investors face a mixed but evolving landscape. While elevated rates historically act as a headwind—reducing present values and discouraging long-term capital commitments—the current cycle is also reshaping market dynamics in a way that may ultimately benefit selective asset owners.
We can consider this as three Phases of Adjustment:
Phase 1: Repricing Mostly Complete
The real estate market underwent a broad repricing beginning in 2022, triggered by the most aggressive Fed tightening since the 1980s. Commercial real estate (CRE) valuations declined over 20% on average, with office properties hit hardest due to both rate pressure and the structural shift to hybrid work.
However, unlike prior downturns, this correction occurred despite rising net operating income. Resilient fundamentals during repricing highlight the sector’s underlying demand strength. By early 2025, signs point to stabilization, with CRE prices beginning to recover modestly.
Phase 2: Supply Shock Restrains New Development
Persistently high interest rates have sharply curtailed new construction activity. Across office, industrial, multifamily, and retail sectors, construction starts are down approximately 75% from their five-year peaks. Office development has declined 83%, while multifamily is down 70%.
These supply constraints, combined with elevated mortgage rates and record-high home prices, have made home ownership increasingly inaccessible. The result: stronger demand for rentals and limited new inventory. In this environment, landlords may benefit from increasing pricing power and upward pressure on rents over time.
Phase 3: Divergence by Asset Quality
The next phase will likely see widening dispersion across asset classes and quality. In the post-zero-rate era, not all properties will perform equally. Office is a case in point: 10% of buildings account for 60% of vacancies, while 40% maintain near-zero vacancy rates. Capital will increasingly favor high-quality assets and operators, while weaker properties may continue to underperform or face obsolescence.
Investment Implications
While elevated rates have introduced volatility and repricing, they’ve also created opportunity. With repricing largely complete and new supply sharply limited, real estate may be entering a new phase of value creation—particularly for high-quality assets in strong markets.
However, selectivity is key. In a higher-rate, slower-growth world, performance will hinge not on broad market exposure, but on owning the right assets in the right locations, managed by experienced operators.
