Navigating Economic Crosscurrents: A Look at the US Commercial Real Estate Landscape in Q1 2025
The US economy in early 2025 has presented a complex picture for commercial real estate, marked by a slight contraction in GDP in the first quarter yet underpinned by robust consumer and investment activity. While recessionary fears linger, a leading real estate firm, CBRE, anticipates average GDP growth of 1.3% for the year, eschewing the classic definition of a recession. However, the interplay of trade policy, inflation, and a softening labour market is set to shape the trajectory of various property sectors.
Economic Headwinds and Tailwinds
The first quarter saw a dip in US GDP, primarily attributed to a surge in imports ahead of anticipated tariffs and a reduction in government expenditure. Despite this, private consumption and investment have remained resilient. The spectre of inflation looms, with its severity tied directly to the scale and duration of impending tariffs and their subsequent impact on product pricing.
The employment landscape, while still robust, is showing signs of softening. The US economy added just over 520,000 jobs in the initial four months of 2025, with unemployment marginally increasing by 10 basis points to a still-low 4.2%. This presents a delicate balancing act for the Federal Reserve, which is expected to implement three 25-basis-point cuts to the federal funds rate this year, aiming to reconcile a loosening labour market with persistent price increases.
The economic outlook is further influenced by legislative progress. The successful conclusion of significant trade agreements and the enactment of a pro-growth tax bill could fuel both consumer spending and business investment. Conversely, a lack of progress on these fronts could dampen economic activity, simultaneously pushing up bond rates and inflation.
Volatility remains a key characteristic of financial markets, as evidenced by the MOVE Index (measuring bond market volatility) and the VIX Volatility Index (reflecting stock market volatility). The 10-year Treasury yield is projected to stay elevated in the low-to-mid-4% range throughout 2025, though continued fluctuations could lead to periodic shifts. This uncertainty is already impacting sentiment, with CEO and consumer confidence hitting their lowest levels since 2012 and 2014, respectively. This cautious mood is likely to temper leasing and sales activity in the near term within the real estate sector.
Sectoral Snapshots: Resilience and Adaptation
Industrial & Logistics: The industrial sector commenced 2025 with strong leasing volumes, reaching over 189 million sq. ft. in Q1, predominantly driven by third-party logistics (3PL) providers. A notable shift in landlord behaviour is emerging, with renewal negotiations now commencing approximately 24 months before lease expiration, a stark contrast to the pandemic era's strategy of delaying discussions to secure higher rents. Trade policy is set to directly influence industrial market conditions, with demand heavily dependent on goods flow. As trade relations with Mexico and Canada strengthen, markets along the I-35 corridor, such as Dallas and Kansas City, are poised to benefit. However, a potential slowdown in industrial leasing could result from reduced consumer spending due to tariff-induced inflation and a softening labour market, particularly affecting large (500,000 sq. ft. or more) and small (100,000 sq. ft. or less) users. Overall, a 5% to 10% reduction in industrial leasing volume is anticipated for the year.
Office: The office sector witnessed an 18% quarter-over-quarter increase in leasing volume in Q1 2025, reaching just over 54 million sq. ft. The recovery, which began in prime New York office markets, has broadened, with 32 of the 40 largest US office markets showing improved net absorption year-on-year in Q1. The latter half of the year's leasing activity will hinge on how trade policy and macroeconomic uncertainty influence business dynamics. Some occupiers are already pausing deals, and a trend towards lease renewals over expansions and relocations is expected, offering savings on moving and build-out costs. Despite this, a 4% increase in office leasing volume is forecast for the year, as most markets continue their post-pandemic recovery. Occupiers are advised to finalise leasing transactions as market conditions gradually favour landlords.
Retail: Retail availability saw a slight increase of 10 basis points in Q1, reaching 4.8%, with absorption turning negative for the first time since Q3 2020. Discount, clothing, and big-box stores are likely to bear the brunt of supply chain disruptions. A slowdown in retail leasing is expected as consumers retrench and retailers face margin compression, potentially exacerbated by higher tariffs. Despite this, the retail availability rate remains exceptionally low due to limited new supply, which should support some strategic deal activity. However, the sector remains particularly susceptible to the evolving macroeconomic climate.
Construction and Capital Markets: A Shifting Landscape
The construction pipeline continues its contraction across all property types. Escalating construction costs, estimated to have risen by 35% since 2020, coupled with higher financing costs, have curtailed speculative development. Retail completions in Q1 2025 were the lowest in over a decade, while multifamily deliveries and industrial completions also saw significant declines. The office sector's under-construction pipeline in Q1 was a substantial 82% below its Q1 2020 level.
In capital markets, commercial real estate investment volume increased by 14% year-on-year in Q1, reaching $88 billion. The outlook remains heavily dependent on trade negotiation outcomes and bond market performance. While spreads have widened, the 10-year Treasury yield is projected to remain in the low-to-mid-4% range, potentially allowing investment volume to increase by up to 8% this year. Downside risks exist from the bond market's reaction to heightened volatility, specifically sell-offs of US Treasuries stemming from concerns over the nation's budget deficit. Despite a more cautious general sentiment, capital remains highly motivated to transact. Multifamily and industrial properties continue to be preferred by investors, while retail and office assets have gained popularity. Alternative sectors have seen less interest as investors capitalise on pricing adjustments in primary property types. Deals are still progressing, albeit with adjustments, and competitive bidding is still observed in sectors like multifamily. The primary challenge remains higher long-term interest rates, though credit flow remains healthy. Debt markets were generally robust in Q1, with all lender types active, though the situation remains fluid.
Amidst these challenges, compelling opportunities are emerging. These include non-prime Class A office buildings in coastal gateway markets, industrial assets along the I-35 corridor benefiting from trade shifts, well-anchored retail centres, Midwest multifamily markets, and data centres driven by structural demand. Opportunities for core capital also exist in long WALE assets, sale/leasebacks, and assets with motivated sellers facing debt maturity. Public-to-private holdings will also attract opportunistic capital.
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