From Underdog to Outperformer: CRE’s Midyear Power Play
As the midpoint of 2025 nears, commercial real estate (CRE) is emerging as the unexpected market standout—outperforming even residential housing in total returns.
According to a recent research report from Principal Asset Management, this marks a rare divergence: Since Q1 2023, CRE returns and housing prices—historically aligned—have split dramatically. CRE total returns turned positive in 4Q24, hitting +2.8% in Q1 2025, while housing slowed to just +3.4% growth over the same period.
What makes this remarkable is that it’s happening outside a recession—something that’s only occurred about 20% of the time since the late 1980s. CRE’s earlier dip—in which unlevered assets fell nearly 20%, levered by over 30%—was offset by strong underlying fundamentals: net operating income rose around 5% in 2023 and 3.2% in 2024, both ahead of historical norms.
Looking forward, Principal forecasts CRE total returns to reach roughly +5% in 2025, driven by steady income amid muted capital gains. Over the next five years, they expect annualized returns to rise to about 7%, and possibly 8–9% over a decade—approaching pre-GFC performance levels.
This midyear inflection arrives alongside longer-term CRE transformations. Over the past 25 years, for example, transaction values have more than doubled even as deal sizes shrink. Industrial and multifamily PSF have jumped 250%+, with deal values rising +254% and +226%, while building footprints thin out—office buildings now 17% smaller on average.
These trends are rooted in shifting tenant demand, rising interest rates, and tighter financing. CRE is now being priced on income and precision—targeting smaller, high-grade, and well-located assets. Meanwhile, housing is cooling under affordability pressures and low inventory, especially in overheated Sunbelt markets. In Q1 2025, Sunbelt regions slowed fastest in home-price appreciation, while Midwest markets led growth.
What does this mean for investors at midyear 2025? First, that CRE is not just rebounding—it’s rewriting real estate playbooks. And strong operating fundamentals, resilient income streams, and a shift to smaller, smarter assets suggest a new cycle where CRE could significantly outpace housing returns. With projected spreads of up to 300 basis points, the CRE opportunity may just be getting started.
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