2024 was set to be the big recovery in real estate with rates lowering setting us up for a great 25. Instead, rates are hovering around 7%, inventory is rising, and long term treasuries are pointing to higher rates for longer. What does this mean for 25? Will 2025 be a recovery from 2024?
On the real estate front, the beginning of the year started out good but as interest rates rose substantially volumes dropped off a cliff and prices began falling in once hot cities. What do the changes mean for residential and commercial real estate in 2025? Will prices have a reset?
Is Denver and indicator for other markets
Before getting into my predictions, I wanted to highlight Denver, one of the pandemic darlings. The chart above is on the national level so it masks over what is happening in particular markets. As you can see from below Denver’s condo market is getting hammered with month’s supply of inventory jumping 42% year over year and prices cooling. For single family homes, inventory is increasing but the picture is not as bad as the condo market, but we all know that as inventory increases, prices ultimately will come down. Denver should be a warning for other high cost markets.
Will survive until 25 pay off
Regardless of prices, real estate is already in a deep recession, with closing volumes down close to 20 year lows. At the same time interest rates are remaining above 7% (as of this writing).
I’ve heard for the past several years, wait until 25, this is when rates were supposed to fall substantially and give the residential and commercial real estate markets a boost. Here we are on the cusp of 25 and it looks like rates and in turn real estate will remain “stuck” for a bit longer. Unfortunately the mantra survive until 25 doesn’t look like it will work out!
Five factors will impact real estate in 2025
Before getting into my predictions for next year, there are three crucial factors to discuss that will shape the real estate market in 2025 and beyond: Interest rates, inflation,housing costs and consumer sentiment. All three are intertwined as they influence each other, but it is important to discuss each one individually to understand how each unique variable will influence real estate in 2025 and beyond.
Inflation: Inflation continues to run about 50% higher than the Federal reserve target of 2%. There should be some break in the continued price acceleration as supply chains “catch up” with demand. Furthermore, we are seeing in the latest retail numbers that prices are starting to dampen demand a little, which will help. Unfortunately, there are a few categories that will remain elevated for a while: housing and wages that will factor into the price of goods.
Housing: As rates have almost tripled from their lows, housing has gotten considerably more expensive due to financing costs. Furthermore supply continues to be reduced due to the lock in effect. Remember housing makes up over 30% of the CPI calculation.
Wages also look to continue higher as the work force remains constrained either from retirements or others not reentering the work force for several reasons. For example, as inflation and wages increase, so does childcare costs which makes it more difficult for many to justify working if they are spending close to what they are making on childcare. I do not see this issue getting resolved until possibly late 23 which will lead to continued upward pressure on wages, but likely not as much as in 2022 as demand wanes a little.
Interest rates: The Federal reserve finally came around that inflation is not transitory and as a result they accelerated the wind down of their bond purchases which will put them in a position to pause hiking rates into 2023. The market has picked up the inflation fight for the fed with long term yields finally heading higher even without additional federal reserve hiking.
Some are predicting a quick reversal in the fed next year. I do not see this happening as they are forced to hold rates higher for longer due to the stickiness of inflation and huge deficit spending that further increases pressure on yields. The early indicators of treasuries echo these sentiments. These factors will keep mortgage rates in the 6.5-7.5% range in 2025.
Consumer Sentiment: Even with inflation running high and rates staying higher, the consumer keeps spending. I think late 25 the consumer starts to get “tired out” as rates crimp demand and they will eventually slow spending down as they work through the last of the pandemic savings. This should help slow inflation, but will not lead to a quick reversal.
Some macro economic wild cards
There are definitely some wild cards in predicting what happens to real estate in 2025 as rates remain high there is increasing probability of something breaking in the economy. Here are three factors I am watching:
- Deficit spending/financing: The federal deficit has basically doubled over the last 3 years and all of this must be financed through the treasury market. As the treasury continues its borrowing rates could continue to spike. I see no end in site to the current deficit spending which will lead to rates higher for longer
- Interest rates/inflation: I’m not convinced that we are totally done with inflation, the labor market is still exceptionally strong which will continue upward pressure on wages and in turn products/services. Rates will have to remain high even in the face of a possible moderate recession
- What breaks? The federal reserve continues touting a soft landing, in order to accomplish this rates will need to remain higher for longer. This drastically raises the risk of something breaking. My first thoughts are commercial real estate and regional banks. But I don’t think the economy will come out of the high rate environment unscathed.
How the three factors above play out could have substantial implications on real estate, for example if something in the economy breaks bad enough like commercial real estate, we could enter a recession with higher unemployment than anticipated. My gut says that rates will stay higher for longer due to the tight labor market and increased deficit spending which ultimately will put pressure on commercial and residential real estate prices.
What are my predictions for real estate in 2025?
2025 looks to be more of 2024, but likely will not happen exactly as economists have planned. Unfortunately, there are more negative than positive risks for real estate heading into the second half of 2025.
In the first half of the year, I do not see the bottom dropping out of prices. There will be some softening with prices dropping in the 5-10% range, some markets will hold steady while others could still increase further. The real test comes in the second half of the year when consumers face the onslaught of bills from credit card sand buy now pay later for all the spending.
Furthermore interest rates will remain much higher than the market is currently anticipating, which will ultimately lead to a reset in the economy.
On the commercial side, high interest rates will continue to put pressure on cap rates. Remember that the higher the cap rate the lower the value (they work in inverse to each other. Office is going to get destroyed with values dropping around 30%-50 overall due to lower demand, higher financing rates, and much higher cap rates. Retail and Industrial will also come off their highs as cap rates continue to rise to keep up with the rise in treasuries. Rents will not be able to rise fast enough to compensate for the higher cap rates.
The wild card is what happens late 2025 as higher interest rates continue to dampen demand; furthermore, the federal reserve must hold rates higher for longer which will keep rates from falling back to their lows. Worst case scenario 10-15% price drops, likely is somewhere under 15% reset in prices. This will not occur until late 2025 as the consumer finally comes to terms with increased borrowing costs and slows down their spending.
Commercial is a different ballgame as commercial properties are at much higher risk for larger price drops and there is not the same lock in effect on residential mortgages as most commercial mortgages are for much shorter terms. For example, large class C office will need a huge reset in prices which could be in the 60%+ range.
Will there be a recession in 2025?
I’m going to put my odds at 40% for a recession in 2025. As rates remain higher commercial real estate values will continue to plunge which will lead to less lending and ultimately more bank failures. Eventually the lack of liquidity will flow through to consumer spending leading to a slowdown. Unfortunately, the risks of recession are mounting as there is always a lag in the economy. Furthermore, I think the market is calling the all clear on inflation a bit too soon and will be in for a rude surprise of higher rates.
Summary of 2025 real estate predictions
2025 is going to be a bumpy year in real estate. We are already seeing signs of this on the residential side with the median prices on condos off 5% in Denver year over year and volumes down 20%. This is just the beginning of the reset in real estate.
Commercial real estate is a whole different animal with rents dropping, vacancy rising, and ultimately prices facing a huge reset especially in the office sector along with retail. If rates remain higher for longer, there will be increasing stress on every commercial property type as cap rates remain elevated.
Anyone in residential or commercial real estate is going to have a tough ride as volumes will stay extremely low throughout the nation until there is a major reset in the economy that forces individuals and businesses to sell and rates to fall substantially. Long and short 2025 looks like a tough year in real estate very similar to 2024. Fortunately every single cycle creates new opportunities and we can always look forward to 2026
It is important to note that as always, real estate is market specific so when we look at the big headlines, that is basically meaningless for your particular market. Higher priced markets like Denver will face considerably more price pressures than a city like Atlanta due to the median price of homes. So although the national predictions are for x or y, take this into account when you are evaluating your particular scenario.
Additional Reading/Resources
- https://www.bloomberg.com/news/articles/2023-11-02/housing-crisis-gets-worse-for-americans-on-mortgage-lock-in-effect?srnd=premium
- https://car-co.stats.showingtime.com/docs/mmi/x/Statewide?src=map
- https://www.wsj.com/business/the-rising-price-of-cardboard-a-positive-sign-for-the-economy-08908d0f
- https://www.fairviewlending.com/why-are-house-prices-still-rising/
- https://www.fairviewlending.com/does-the-trump-election-matter-for-real-estate-homes-sales-lowest-since-95/
- https://www.fairviewlending.com/federal-reserve-cuts-rates-should-you-rejoice/
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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