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Uncertainty is high. Higher uncertainty translates to higher risk. Investors will need to decide if and how much of a risk premium they may now require, which typically causes the market to pause and reassess. US real estate is likely in one of those reassessment phases right now, hoping to buy itself enough time for de-escalation of trade disagreements. In the meantime, transaction volume is probably not going to reach the highs we were hoping for in 2025. Leasing velocity may also be slower in 2025 than forecasters had hoped. Yet, real estate markets are in a good position with supply growth subsiding and staying low. Demand may be strong enough to weather some weakness.

As investors adjust to changing market conditions and debt markets thaw, buyers should find more opportunity to get deals funded. Despite some interest rate volatility, Treasury rates ended the first quarter below where they started, and lenders have fresh capital to put out in 2025.

Figure 1: NCREIF property sector total returns (ODCE properties, quarterly total return, %)

After a 40% increase year-over-year in the fourth quarter, 1Q25 transactions volume was 10% above 1Q24 at USD 98 billion. In 1Q25, real estate returns rose across the board (see Figure 1), marking the first quarter of unanimous good news since 2022. Increased debt availability and slowing construction pipelines should help create some optimism among real estate investors this year, despite the cloud of economic uncertainty.

Prices are still more attractive than they were at the peak three years ago, and for investors who are able to take a longer-term view, 2025 may still be a good reentry point for the real estate market. Slowing construction pipelines should tilt lingering supply-demand imbalances in landlords’ favor over the next several years (see Figure 2).

When demand outpaces supply, rents should rise across sectors. Ultimately, prospects for rising rents and growing investment income will help unthaw real estate capital markets.

Uncertainty clouds economic expectations

The US economy shrank by an annualized 0.3% during the first quarter of 2025, its first contraction since 1Q22. This decline was largely driven by a record trade deficit, as businesses stocked up on imports ahead of the anticipated tariffs. The surge in imports reduced GDP by 4.8%. Consumer spending, which makes up approximately two-thirds of GDP, moderated to a 1.8% increase. Business investment stayed strong, primarily due to companies temporarily stockpiling inventory to avoid higher costs from tariffs. Although the US economy contracted during the first quarter, the labor market remained solid. Monthly nonfarm payrolls averaged 132,000 during the first quarter and recently came in above consensus at 177,000 in April. The unemployment rate was unchanged at 4.2%.

Fed’s Next Moves

The US economic outlook has become increasingly uncertain, as escalating geopolitical tensions disrupt trade, fuel market volatility and cause inflationary pressures. The Fed has taken a more cautious approach to policy decisions in light of these growing uncertainties. During the latest meeting in May, the Federal Open Market Committee (FOMC) decided to maintain the federal funds rate at 4.25% to 4.5%, as they wait for clearer signals on how inflation, unemployment and economic activity are shifting.

One of the key metrics the Fed monitors to gauge inflation is the core Personal Consumption Expenditures Price index (PCE), which although moderated to 2.6% in March, is expected to pick up as retailers raise prices to offset higher costs driven by import tariffs. Between the macro economy and inflation data, FOMC members are projecting a median of two rate cuts by the end of 2025. All else equal, the impact of lower interest rates will improve values, as the cost of borrowing becomes less expensive.

Expectations for 2025

Over the course of 2025, we expect growth to continue to moderate. Higher US tariffs and increased uncertainty will likely put pressure on GDP growth in the second quarter. However, an improved trade deficit will partially offset some of this drag. The trade deficit’s projected to improve in the second quarter, due to an expected steep decline in imports after their recent sharp surge. Although the level and duration of tariffs remain uncertain, markets are anticipating a partial rollback of tariffs, similar to the recent adjustment made with the UK Moody’s Analytics expects GDP to grow by an annualized 1.3% in 2025, a notable slowdown from 2024’s 2.8% growth. However, the effects of tariffs will continue to be a key factor in shaping future economic expectations.

The apartment sector

US apartment demand outpaced completions during 1Q25, as markets moved beyond the peak of the recent supply surge (see Figure 2). At a little over 70,000 units delivered, first quarter completions were 47% below 3Q24’s peak. During this period, just over 100,000 units were absorbed, driving vacancy down. The vacancy rate fell 20bps over the quarter to 4.8%, the lowest level since 2Q22. Despite tighter market conditions, rents increased marginally by only 0.9% YoY.

Transaction volume for the quarter was 35.5% higher than 1Q24 levels, suggesting that buyers are taking advantage of the possibility of acquiring at a discount despite economic uncertainties. The ODCE NPI apartment sector delivered an annual total unlevered return of 4.0% in the year ending March 2025.

The industrial sector

Industrial demand continued to soften in 1Q25, with postponed expansion plans amid economic uncertainty contributing to the slowdown. Although completions outpaced demand during the quarter, the pace of new deliveries slowed significantly – down 51.7% from 2Q24’s peak. Availability increased 30bps over the quarter to 8.9%, the highest national availability rate since 3Q15. Industrial rents were flat year-over-year, as elevated availability weighed on rental increases.

Despite softening fundamentals, transaction activity picked up slightly. Transaction volume for the quarter was 24.4% higher than 1Q24 levels. Industrial values rose for the third consecutive quarter, contributing to an ODCE NPI annual total unlevered return of 4.1% in the year ending March 2025.

The office sector

At the end of 2024 we warned that, “Office fundamentals improved for the first time in three years, but the sector is far from recovery.” Unfortunately, a decline in tenant demand during 1Q25 proved this point. Downtown Class A properties marked the only subsector with positive demand, while Suburban locations and mid-to-low quality office buildings struggled. For the fifth consecutive quarter, office vacancy hovered near 19.0% nationally, supported mainly by slowing supply growth. During 1Q25, two million sqft of office delivered in the US, representing the lowest level of new supply since 2011.

Transaction activity was mixed. Sellers lost momentum in suburban locations with transactions down 33% over the year. However, downtown office transactions increased 25% during the same period. For the first time since 2Q22, the NPI ODCE Office return was positive, increasing by 1.1% during the quarter, bringing the one-year total return to –1.7%. While the worst of the downturn may be over for the office sector, a return to pre-pandemic performance will likely take many years.

The retail sector

Retail outperformed other major real estate sectors during the first quarter, though looming economic risks make the sector’s continued dominance less certain. The retail sector delivered an ODCE NPI total unlevered return of 8.5% in the year ended 1Q25, outperforming the industrial, apartment and office sectors. Retail sales rose 4.5% year-over-year in 1Q25 supported by low unemployment and a temporary boost, as retailers built up inventory ahead of tariff increases.

Leasing demand at neighborhood, community and strip shopping centers fell during 1Q25 for the first time since 2020, but low levels of construction helped keep the vacancy rate at 6.6%. Retail transactions for the quarter were up just 2% compared to 1Q24, a sign that buyers are not yet rushing to the table in response to retail’s strong fundamentals. Improving capital market conditions should support more activity once underwriters can factor in more clarity on the economy.

Figure 2: Sector fundamentals (%)