3 Signs CRE Investors Are in for a Turnaround

“Timing is everything.”

“You can’t time markets.”

If you take these two axioms together, they suggest that while timing matters in investing there isn’t much someone can do about it. While this adage has largely proven true in public markets, it applies less in private markets. Through multiple cycles, we have seen some empirical signals that help commercial real estate investors determine if the timing is relatively favorable or unfavorable for investment. Here, we highlight a few important ones.

The first signal is pricing. CRE capital markets tend to move in relatively long, pronounced cycles. They do not typically exhibit the randomness often found in the public capital markets. In practice, that means prices tend to rise (and relatedly cap rates fall) in a correlated way—what happened last quarter tells you something about what’s likely to happen this quarter. And what happens this quarter will tell you something about what’s likely to happen next quarter. Therefore, cap rates bottom out when pricing is generally at its highest and most aggressive. Past peak, pricing will weaken slowly and then accelerate. After a period of more rapid price declines, the change slows and eventually pricing bottoms and cap rates peak. Then the cycle reverses, with pricing improving slowly, then accelerating, etc. So where are we now? The market has not quite found a bottom in pricing, but the deterioration has slowed, and stabilization is nearing. That strongly suggests valuations will broadly increase in the not-too-distant future, slowly at first and then should accelerate.

But can we trust that dynamic on its own? Thankfully, we don’t have to. The second signal is monetary policy. Historically, over the last six monetary cycles, once the Federal Reserve stopped raising interest rates, total returns quickly switched from negative to positive, as appreciation returns (reflecting pricing) became less negative. As the Fed switches from holding rates steady to cutting rates, appreciation returns accelerate and remain in positive territory for years, owing to the long, cyclical nature of CRE capital markets referenced above. So where are we now? Thus far, the Fed has cut 75 basis points. Appreciation returns have not yet turned positive, but they have become less negative over the last few quarters, pushing total returns into positive territory. As the Fed continues to cut interest rates, that should further drive valuations, appreciation returns and total returns, all of which should accelerate in the coming quarters.

Finally, we don’t have to rely exclusively on internal private market signals. We can look for external signals from the public markets, particularly the equity markets. It has been well established that public markets, which respond quickly to external factors, lead private markets. That is true broadly, but also for public real estate like REITs. These public markets provide a solid leading indicator of where private markets are headed. This has been proven true over multiple market cycles stretching back decades. So where are we now? Public markets have performed well this year. The broader equity markets continue to hit record highs. While the real estate sector has lagged the overall equity markets, it has generally produced positive returns in 2024. Following the established pattern, that bodes well for private CRE returns.

Timing a market, any market, remains a challenge. And we wouldn’t put too much faith in any one metric. The three signals presented here, taken together, can help to guide investor decisions. Investments will always involve some level of risk and uncertainty, but developments over the last year or so provide greater confidence that the CRE investment market has turned a corner and that better times lie ahead.

Read the December 2024 issue of CPE.