CRE Bargain Era Ends, Landlords Must Boost

The window for buying commercial real estate at a steep discount has closed, forcing landlords to boost net operating income to create value. With property valuations firming and interest rate relief receding, analysts say the next market phase will reward skilled operators over opportunistic bargain hunters.

A shift in the outlook for interest rates and the broad availability of debt have transformed capital markets. The focus is no longer on finding cheap assets but on unlocking value through operational improvements to boost net operating income, or NOI. This theme is consistent across midyear reports from several major firms. Analysts from UBS, Principal Asset Management, and Newmark have expressed similar views in their recent analyses.

The End of Valuation Recovery

Price resets for commercial assets are largely complete. According to UBS analysts, the key differentiator now is earnings delivery, not waiting for valuation recovery. Performing assets are also benefiting from a sharp decline in new commercial construction in recent years.

Principal Asset Management analysts noted that cap rate compression is unlikely, especially with interest rates higher. Owners must therefore adjust their strategies to continue growing asset values. The firm's report states that income historically drives about 85% of total returns over a market cycle.

A recent CBRE survey found that the share of investors expecting cap rates to compress has fallen significantly. Cap rate stagnation is now the most likely outcome for the next six months.

Transaction and Debt Momentum

Sales data indicates the commercial real estate market is in an early recovery phase. While distress exists, widespread available capital and flexible lenders have limited deeply discounted sales. U.S. transaction volume for the first half of the year reached $293 billion, a 31% year-over-year increase and the strongest first half since 2022.

Newmark reported the rebound was partly driven by a surge in large trades over $250 million. Deal volume rose across all asset classes, with REIT acquisitions jumping 86% from the prior year.

Debt origination rose 25% year-over-year, though capital is more often used for refinancing than for new acquisitions. MSCI data shows commercial real estate prices were up roughly 20 basis points year-over-year in July, despite the 10-year Treasury rising about 50 basis points since January.

Operational Shifts Across Sectors

With core sectors performing, landlords are pivoting to operational improvements. Apartment owners are beginning to see rent growth after relying on concessions, as occupancy stabilizes above 95%. Industrial leasing activity has increased compared to last year.

In the office sector, the best towers in top markets have no vacancy, pushing businesses to consider space in the next tier of properties. JLL Capital Markets CEO Richard Bloxam noted that the wide availability of debt is directly translating into more deals as commercial mortgage markets grow competitive.

Investors are also adjusting to a new macroeconomic reality. Billions of dollars were previously sidelined waiting for Federal Reserve rate cuts. Now, with inflation above the Fed's 2% target and a stable labor market, the predominant investor theme has shifted to the potential for further rate hikes.

Newmark analysts warned that waiting for easier monetary policy is no longer a viable strategy. The prospect of rate cuts dimmed further after a late August speech by Federal Reserve Chairman Kevin Warsh. He stated current Fed rates were not broadly restrictive to capital markets. Markets reacted by pricing in a higher likelihood of a rate hike at the September meeting. CME Group's FedWatch tool indicates a 68% likelihood of a quarter-point increase.