Interest Rates

Over the past three years, forecasts have consistently underestimated interest rates, a stark contrast to the preceding two decades, when nearly every forecast overshot expectations. After more than 20 years of rates trending below projections, investors have grown accustomed to leaning in a particular direction when assessing interest rate risk. However, the economic fundamentals have shifted significantly. The unprecedented disruptions caused by COVID, coupled with the massive economic stimulus that followed, were highly inflationary. While much of this inflationary pressure has been absorbed, monetary growth began accelerating again in 2024, signaling the likelihood of renewed inflation in the near future.

We anticipate that resurgent inflation will significantly reduce the likelihood of further interest rate cuts in 2025, although political pressure may make additional rate hikes equally challenging. However, unless government deficit spending slows, inflation will eventually necessitate tighter monetary policy. For 2025, we expect inflation to rise noticeably from its current levels but fall short of the peaks seen in 2022. The 10-year Treasury yield is likely to remain near its current level of 4.75%, with the potential for a decline if signs emerge that inflationary pressures are easing.

Commercial Real Estate

In commercial real estate, we see a market that remains mixed but has generally improved from the challenges faced in 2023 and 2024. The industrial sector stands out as a continued growth leader, driven by the ongoing expansion of e-commerce and trends like reshoring, which are fueling demand. While the industrial market has cooled slightly from the red-hot surge it experienced during the pandemic, it remains fundamentally strong and poised for sustained growth. This sector is expected to remain a favorite among investors, likely leading to further compression of yields relative to interest rates.

The office sector is poised to be the surprise of 2025, with major firms like JLL, CBRE, and Colliers projecting a substantial tightening in the market, particularly for top-tier properties. The post-COVID return to work is nearly complete, with approximately 90% of employers mandating a return to the office by the end of 2024. Additionally, a majority of CEOs anticipate that all companies will fully transition back to office environments by 2026. For the first time in five years, more businesses are planning to add office space than reduce it, signaling a potential turning point for the sector.

The push to return to the office, coupled with a persistently tight labor market, is driving companies to secure high-quality spaces for their employees. However, the supply of such premium office spaces is exceptionally limited and is expected to remain so for the foreseeable future.

Rental rates for office properties have largely missed out on the broad inflationary trends of recent years, even as tenant improvement costs have skyrocketed. Distressed office landlords have been forced to lease space at rates that barely cover these expenses, simply to keep buildings occupied. However, this dynamic is likely to shift as the market for high-quality office spaces tightens. Landlords are expected to return to more profitable lease arrangements, which will compel tenants to either absorb the rising costs of buildouts or opt for more budget-friendly spaces.

Office investments have endured significant challenges over the past five years, and it will likely take considerable time for a full recovery. However, these challenges may also lay the groundwork for underinvestment and eventual price increases. Will 2025 be the turning point? While we can’t say for certain, we believe that purchasing office property in 2025 has strong potential to be a sound long-term investment.

The road ahead may be uncertain, but understanding these trends can help guide strategic decisions and uncover opportunities in an ever-changing environment. Whether in the markets, the economy, or real estate, 2025 promises to be a year of significant movement and potential.