While many financial advisors continue to bet on commercial real estate investment for the long term, the past couple of years have been tough for the sector, particularly on the private side. Investment sales transactions came to a halt, and rising interest rates made refinancing harder. The collapse of Silicon Valley Bank and Signature Bank, with their sizeable real estate portfolios, spooked investors. Non-traded REITs were still dealing with outsized redemption requests at the beginning of this year.

Granted, things have been looking up in recent months. On the publicly traded REIT side, the FTSE NARIET All-Equity Index will likely post double-digit growth in total returns for 2024. Investment sales activity began slowly coming back to life. The Federal Reserve finally started cutting interest rates in September and announced another 0.25% cut on Dec. 18, bringing its benchmark rate to between 4.25% and 4.50%.

Related: Solid Fundamentals and a Stable Economic Outlook Portend a Solid 2025 for REITs

However, while both the public and private real estate markets have finally reached a trough in valuations, don’t expect a particularly rosy outlook for 2025, notes Richard Hill, senior vice president and head of real estate strategy and research at global investment management firm Cohen & Steers. Returns on commercial real estate will be in positive territory, but they will be below historical averages, he predicts. The aim for financial advisors will be to pick opportunities in the right property sectors and markets to deliver above-average returns.

WealthManagement.com spoke to Hill about why overall returns will likely remain in the low to mid-single digits, how opportunities for distressed debt investment might be overestimated and why advisors should consider blending public REIT exposure with private real estate allocations.

Related: Ten Issues Facing Commercial Real Estate

This Q&A has been edited for length, style and clarity.

WealthManagement.com: What’s your outlook for the commercial real estate investment market overall in 2025?

Richard Hill: We do think public and private valuations have troughed, and private valuations will begin to rebound in 2025. It’s been a long drawdown over the past two years, but we think we are going to be in positive territory in 2025. I want to be clear, though, that we don’t expect this to be a V-shaped recovery like what we saw coming out of the Great Financial Crisis. Our return expectations are probably below historical averages in the low single digits. That’s driven by two factors. Global central banks are not providing stimulus like they did in prior downturns. But maybe more importantly, this is going to be an uneven recovery across property types. Some property types will do quite well, and some property types won’t do as well. It’s a little bit of a nuanced headline—2025 will be the first time in more than two years when returns will start to rise, but it will not be a robust recovery.

WM: How do you think the publicly traded REIT market will perform? What will we see there?

RH: Listed REITs troughed in October of 2023. That’s important because listed REITs are leading indicators in both downturns and recoveries. Listed REITs were down more than 15% in 2022, while private valuations were still up. Fortunes have reversed over the past two years, though, where listed REIT valuations were up more than 10% in 2023, while private was down. Year-to-date, they are up a little more than 8%, while private is still down.

I do anticipate that listed REIT returns will remain positive in the year ahead, but some headwinds are beginning to face the sector, particularly higher interest rates [compared with periods when the Fed’s target was 0%]. We think positive earnings growth and dividend yield will help mitigate some of that. But at the index level, we are probably talking about mid-single-digit returns for the year ahead, so some moderation relative to what we saw in 2023 and 2024. The really important point here is that there can be far superior returns through active management. The reason I say that is most people think about listed REITs as a singular sector. But in reality, it’s 18 different sub-sectors that will behave very differently. A lot of people will be surprised to learn that usually there is around a 50 to 60 percentage point difference between the best sector and the worst sector. This is a market where we are pretty excited about the ability to deliver alpha through active management, even if index-level returns are normalizing a little bit compared to what we saw in the past couple of years.

WM: Can you give an example of what that may look like in terms of how you can use active management to drive those outsized returns?

RH: Let me give you an example from this year. Believe it or not, industrial properties, despite the private markets really liking them, are the worst sector of the public REIT market, down 15%. The listed REIT market is telling you that maybe some headwinds are coming for the industrial sector.

On the other hand, if you look at what the best-performing sectors are, it might really surprise some people. It’s things like regional malls are up more than 30%, healthcare is up 27% and data centers are up almost 29%. Believe it or not, office, which is a much-maligned sector, is up almost 28% year-to-date. So, you are starting to see a rotation in listed REITs where some of the best-performing sub-sectors in the past are not necessarily the best-performing sub-sectors going forward.

WM: Are there any additional notable trends in the public sector that we might see in 2025?

RH: There is one very significant trend that I don’t think is getting enough attention. We think public REITs are going to become net acquirers of properties for the first time in 10 to 15 years. The public markets inject discipline in listed REITs; they force them to sell assets as commercial real estate valuations are rising, and then they say it’s okay to buy assets at the beginning of cycles. If you go back and look at historical cycles, listed REITs became net acquirers of assets in the early 2000s and post-Great Financial Crisis. We think that’s going to happen again, and it’s probably something that the market is not spending enough time thinking about because if that’s the case, earnings might become a little better than anticipated.

WM: There has been that long-term divergence in valuations between the public REIT market and the private market that you mentioned earlier. How much has that narrowed and what have been the implications for transaction activity?

RH: The private commercial real estate market usually troughs 12 to 18 months after the listed market troughs. We think we are in the process of going through that work right now. But there is actually something that I think is confusing to a lot of investors. Distress in the debt markets, delinquencies, for instance, usually don’t peak until 12 to 24 months after private valuations trough. So the headlines are going to get pretty bad, and they are certainly going to get worse before they get better in 2025. You are going to see all these headlines about borrowers returning the keys to the lenders and about valuations declining. It’s reflective of the last stage of the grieving process, which is acceptance.

What does this mean for transaction volumes? I do think transaction volumes are going to be higher on a year-over-year basis, and a lot of it has to do with easy comps. There was not a lot of transaction volume in 2024, it’s only been in the prior two quarters when transaction volumes began to stabilize a little bit. So, while I think transaction volumes will rise in 2025, it’s not going to be nearly as robust as what we saw in 2020, 2021 and 2022. It’s probably going to normalize back to volumes more closely aligning with what happened in 2019.

One angle that we want to add is that one of the biggest criticisms of listed REITs is they tend to be more volatile than private valuations. But I think the market is beginning to recognize that volatility is not necessarily a bad thing. With volatility, it means you have a more liquid asset class. Private real estate is not liquid. You can’t get into it when you want to, and you can’t get out of it when you want to. So, I think investors have a greater appreciation, given what happened to private real estate over the past couple of years, that having listed REITs within your portfolio to help manage illiquidity is actually really important.

The second point is that listed REITs tend to zig when private real estate is zagging. You can smooth out returns by adding listed REITs to a private real estate portfolio. I think more investors are beginning to recognize that listed REITs can be a very powerful tool for increasing returns, mitigating volatility and giving you a greater ability to increase your allocations to listed REITs and lower them in a much more dynamic format.

WM: Where are private real estate valuations right now compared to their cycle peak?

RH: We think unlevered property valuations are down about 20% from their peak right now. I mentioned that we thought total returns would be positive in 2025. What that means is that unlevered property prices will probably decline another several percentage points or so, but we’ve reached an equilibrium where income returns are now offsetting negative price returns.

So, I think negative price returns haven’t troughed yet. They will probably trough in the negative 23% to negative 25% range. But income returns are now offsetting those declines in property prices. To put a bow on this, we think unlevered price returns are down about 20%, they have a little bit further to decline before they reach the trough, but total returns have already troughed.

WM: What does the capital availability picture look like right now, especially for private real estate? Where do we stand in how easy it is to secure financing or refinancing?

RH: First of all, there’s been a lot of talk about dry powder on the sidelines, money that’s been raised but not yet deployed. It peaked at around $675 billion in December 2022 and has risen at an almost 11% annual growth rate since 2010. So, a lot of money was on the sidelines, waiting to invest in commercial real estate. This dry powder seems like it’s finally beginning to be deployed. It actually declined by more than 40% over the prior two years and now stands at around $372 billion. So, investors are finally taking advantage of this decline in real estate valuations that we just discussed.

But commercial real estate is inherently a levered asset class. Not many people buy a building and don’t put any level of debt on it. Lending standards are turning less bad. We closely follow the Senior Loan Officer Opinion Survey, a quarterly survey published by the Federal Reserve. At its peak, around 70% of lenders said they were tightening lending conditions. Today, it’s less than 20% that are tightening lending conditions. So, a far greater percentage of lenders are no longer tightening.

If we break this down, large banks actually started lending again. Particularly for some asset classes, like multifamily, lending conditions are loosening now, and loan demand is increasing. There’s actually a really interesting dichotomy occurring between large banks that are finally beginning to lend again and small banks, which are not lending. I want to make one point about small banks, though. There is a lot of discussion saying small banks are not going to lend on commercial real estate like they have in the past. I think that’s partially true. I don’t think small banks are going to lend to the same degree that they did in the prior cycles. But I think they will shift in how they lend to commercial real estate. They are going to lend to companies that lend on commercial real estate, so they are going to indirectly lend to commercial real estate.

But banks aren’t the totality of the commercial mortgage market, either. Insurance companies are having a great time right now. They are finally able to lend on higher-quality properties at returns that make sense to them, and the CMBS market absolutely boomed in 2024. I think these are green shoots that suggest that in the second half of 2025, lending standards will finally begin to loosen.

WM: How will the environment you just described impact distressed debt opportunities?

RH: We are in the very early innings of distress in the commercial real estate debt markets. Distress usually picks out 12 to 24 months after private valuations trough. So, we think there are significant opportunities in the distressed market. Unlike coming out of the GFC, there is a wide variety of different investors that are willing to buy those loans. I think this is beginning to open up. We are getting to a place where lenders are feeling comfortable resolving their distressed loans, so this will be a pretty big opportunity. I don’t think it’s as broad-based as the market perceives it to be. We think debt funds are going to rise in importance, but their market share is probably going to tap out at about 20% of total lending. So yes, distress is still rising, yes, it’s a big opportunity to buy distressed loans, but it’s probably not as big of an opportunity as the market perceives. It’s a great opportunity to add alpha to a portfolio, but it’s hard to make it a core portfolio holding.

WM: Zooming out to a bigger picture, with the declining yields on U.S. Treasuries, will that impact how attractive investment in real estate is going to look in 2025?

RH: We think the market has become conditioned that interest rates are all that matters for commercial real estate valuations. They are certainly very important because commercial real estate is an inherently levered asset class, but they are not the only driver of commercial real estate valuations. We think net operating income growth and loosening lending conditions are quite positive. You can have valuations that rise in a rising interest rate environment so long as net operating income growth is accelerating, lending conditions are loosening. And that’s a reasonable backdrop to 2025.

In a rising inflation regime, given the correlation between net operating income growth and inflation, you should see that growth continues to improve. And given that lending conditions are already tight, I think you are going to start to see a loosening. Maybe one of the more interesting points I don’t think the market is connecting the dots on is that the market thinks financial institutions are going to do quite well in 2025 under the new presidential administration. It’s really hard to say that financial institutions are going to do well, but commercial real estate is going to remain really tight. We think it’s quite possible that interest rates can remain at the level they are in commercial real estate and do okay if NOI growth is accelerating and lending conditions are loosening, which we think is a fair outlook.

WM: Developing that thought further, how might the new presidential administration and its policies impact the outlook for commercial real estate?

RH: The first point I would make is that we’ve seen this before. In 2016, the knee-jerk reaction was to sell commercial real estate and listed REITs, but it ended up being quite a fine environment for both. I do think the loosening of regulation for financial institutions will be good for commercial real estate because it will make it easier for banks to lend on commercial real estate.

The final point I would make on this is there is tremendous focus on tariffs and rightfully so, but keep in mind U.S. commercial real estate is a domestic asset class. There are some subsectors that could be modestly impacted by tariffs, but in aggregate, tariffs are not impacting multifamily, they are not impacting office properties, they are not impacting open-air shopping centers. I think there is a scenario where money is drawn to the U.S. commercial real estate market because it is insulated from things like tariffs.

WM: Can you discuss more in-depth what you’ve seen in recent months in terms of deal activity in the private market?

RH: In 2Q, we saw deal activity modestly rise on a year-over-year basis, but that included a significant take-private of a listed REIT by Blackstone. So, there were some questions about whether deal activity would remain stable in 3Q on a year-over-year basis, and it did. Now we have two quarters of stabilizing year-over-year transaction volumes. I don’t want to give you the impression that deals are suddenly accelerating higher because they are not, but I do think part of the bottoming-out process is to see stabilization in transaction volumes on a year-over-year basis, and that’s where we are.

Why is that occurring? Sellers finally have a greater appreciation for where buyers want to buy. Two years ago, 12 months ago, that was just not the case. Sellers were holding out for valuations that we don’t think are coming back over the near term. Now, those sellers have made their way through the grieving process and are accepting that this is a different environment than two or three years ago. So, there is a meeting of the mind between buyers and sellers that hadn’t existed previously, and it’s going to provide some stability to transaction volume. But we are probably not at a place yet where transaction volumes are going to be significantly accelerating higher in 2025. We think that’s probably a 2026 and beyond story.

WM: You mentioned that we will likely see public REITs become net acquirers of assets. Who do you think will be some of the other initial buyers in the private market?

RH: I think your sellers are going to be whoever was the biggest acquirers over the past 10 to 15 years. Some of the commercial real estate open-ended funds still need to sell some properties to manage liquidity needs. But what we are starting to see is super high-net-worth family offices across the world are stepping in and beginning to buy even things like office properties, which might surprise people.

Why are they doing that? It’s because they take a 100-year view of commercial real estate. So, I think it’s going to be listed REITs, it’s going to some sovereign wealth funds, and it’s going to be some ultra-high-net-worth individuals. What I am saying is any investor that has long-term capital and can take a long-term view on commercial real estate will be getting their toes in, saying, “This is one of the best opportunities in a generation to step in and buy commercial real estate.”

WM: For investors who come into the market in 2025, what kinds of returns will they be looking at?

RH: The way we think about this is that headline returns are going to be below historical averages. Headline returns for private real estate are probably going to be in the low single digits, and headline returns for listed REITs at the index level are going to be in the mid-single digits.

But this is a really attractive opportunity for active management driven by the right property types in the right markets. We think open-air shopping centers have been an asset class that has been red-lined by investors in the private market for the better part of 10 to 15 years because of the retail apocalypse. Fundamental direction there is really strong, occupancies are at historical highs, and that’s because no one built new open-air shopping centers over the past 10 to 15 years and then COVID right-sized the rest of the market. At the same time, retailers have a greater appreciation that they can use their physical real estate to satisfy micro-fulfillment for the consumer. All of this is leading to an environment where the balance of power shifted back to the landlord, and why occupancies are at historical highs.

I go back to the comment I gave you at the beginning that many investors think about commercial real estate as a single asset class. But, in reality, it’s not. There are 18 different sub-sectors, there is always value to be found somewhere in the market. So, while headline returns might be below historical averages, we think investors who can focus on fundamentals can actually produce returns that are far superior to that.

WM: Which property sectors are likely to lag in this recovery?

RH: I think the private market owns too much industrial property right now. And frankly, I feel they own too much multifamily as well. If you look at open-ended funds that own core commercial real estate, around two-thirds of their holdings are in the industrial and multifamily sectors. I understand why because those asset classes performed remarkably well. But usually, what outperformed in the prior cycle does not outperform in the next cycle.

If you look at what happened in 2024, open-air shopping centers have been the best-performing sector of private commercial real estate, which probably surprised a lot of people. While office continues to face headwinds, I think if you take a 10-year view, I would have a hard time not putting office at the very top of some of the best-performing property types. It may not happen today, tomorrow, next month or even next year, but at some point, the office sector is going to turn around.

So, we are trying to be a little contrarian here. We like open-air shopping centers and we are trying to figure out what comes next. I think there are a lot of investors who are beginning to look at the office sector because of the shifts that are beginning to emerge.