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Welcome

As we close out 2024, the real estate market stands at a crossroads of challenge and opportunity. Today’s edition unpacks the surprising ripple effects of yesterday’s Federal Reserve rate cut on mortgage markets, alongside a comprehensive look at residential, commercial, and REIT sectors. From cautious optimism in housing to the potential “year of reckoning” in commercial real estate, we’ll navigate the complex landscape shaping the industry’s future. Join us as we analyze the trends and insights critical for success in the evolving real estate environment of 2025.

Key Takeaways

• Mortgage rates expected to decline modestly in 2025, but remain above 6% with potential volatility Fannie Mae

• Existing home sales forecast to rise 4.8% in 2025, reaching 4.251 million units Inman

• Commercial real estate faces challenges, particularly in the office sector, with potential for a “year of reckoning” in 2025 Bloomberg

• CMBS delinquencies accelerated in recent months, with office delinquency rate reaching 11.2% in November Bisnow

• REITs expected to face challenges but may benefit from potential economic recovery and lower interest rates in 2025

• Federal Reserve cuts interest rates and markets revolt

Residential Real Estate Markets

The residential real estate market in 2025 is poised for a modest recovery, albeit with significant regional variations and ongoing affordability challenges. According to Fannie Mae’s latest forecast, existing home sales are expected to increase by 4.8% in 2025, reaching 4.251 million units Inman. This uptick comes after a prolonged period of subdued activity, primarily due to affordability issues and the “lock-in effect” caused by historically low mortgage rates in previous years.

Mark Palim, Fannie Mae’s Chief Economist, predicts that “2025 will look a lot like 2024, with mortgage rates above 6 percent, home price growth easing from recent highs but staying positive, and supply remaining below pre-pandemic levels” Fannie Mae. However, there’s a silver lining for potential homebuyers: nominal wage growth is expected to outpace home price growth for the first time in over a decade, which could gradually improve affordability conditions.

Regional disparities will play a significant role in the 2025 housing market. Sun Belt states, parts of the Mountain West, and the Pacific Northwest are anticipated to see stronger housing activity due to robust construction and rising inventories. In contrast, the Midwest and Northeast may continue to lag, with inventory levels significantly below pre-pandemic norms Inman.

The National Association of Realtors (NAR) has identified 10 “hottest” housing markets for 2025, including Boston, Charlotte, Grand Rapids, Greenville, Hartford, Indianapolis, Kansas City, Knoxville, Phoenix, and San Antonio. These markets are characterized by favorable economic and socio-economic trends, such as job creation, positive net migration, and a healthy supply of starter homes HousingWire.

Mortgage Markets

The mortgage market in 2025 is expected to see some improvements, but challenges will persist. Fannie Mae forecasts that average mortgage rates will decline modestly but remain above 6 percent, with potential bouts of volatility Fannie Mae. This prediction aligns with other industry forecasts, such as Redfin’s projection of mortgage rates hovering around 6.8% The Hill.

The Mortgage Bankers Association (MBA) is optimistic about mortgage origination volume, forecasting a 20% growth in 2025 compared to 2024. Mike Fratantoni, MBA’s Chief Economist, stated, “I’m optimistic about spring 2025. I think all the factors are lining up that we could really see the increases that we’re talking about and inventory really being the one to focus on” Inman.

The mortgage market experienced significant volatility in the wake of yesterday’s Federal Reserve decision to lower interest rates. On December 18, 2024, the Federal Open Market Committee (FOMC) voted to cut the federal funds rate by 25 basis points, bringing the target range to 4.25% to 4.5% HousingWire. This marks the third consecutive rate cut since September, cumulatively reducing rates by a full percentage point this year.

Despite the rate cut, which typically would be expected to lower borrowing costs, the mortgage market reacted counterintuitively. The yield on the 10-year Treasury note, a key benchmark for mortgage rates, climbed by 11 basis points as Federal Reserve Chair Jerome Powell briefed reporters Inman. This surge in Treasury yields led to an immediate impact on mortgage rates, with the Mortgage News Daily index showing rates on 30-year fixed-rate mortgages soaring by 21 basis points on Wednesday, reaching 7.13% Inman.

The market’s reaction appears to be driven by concerns about future inflation and the Fed’s more cautious stance on rate cuts in 2025. The latest “dot plot,” which indicates where each Fed policymaker expects short-term rates to be in the years ahead, showed little enthusiasm for aggressive rate cuts in 2025 Yahoo Finance. This shift in expectations has been priced into the market, resulting in higher 10-year Treasury yields and, consequently, higher mortgage rates.

Mike Fratantoni, Chief Economist at the Mortgage Bankers Association (MBA), commented on this development, stating, “Expectations that the Fed will cut rates less than had been anticipated have been priced into the market in the form of higher 10-year Treasury and higher mortgage rates in recent weeks” MBA. The MBA has adjusted its forecast for mortgage rates in response to these changes, now projecting that rates will average close to 6.5% over the next few years, with significant volatility around that average.

The implications of this rate environment for the housing market are substantial. While the Fed’s rate cuts were intended to provide some relief to borrowers, the market’s focus on inflation risks has effectively negated much of the potential benefit for homebuyers. Eric Orenstein, senior director at Fitch Ratings, noted that “inflation risks have kept treasury yields higher even with the Fed’s third consecutive rate cut, though mortgage originators will benefit from higher volumes in 2025 with nearly $2 trillion of outstanding mortgages above 6%” HousingWire.

However, the “lock-in effect” continues to be a significant factor in the mortgage market. With about two-thirds of outstanding home loans having a rate below 4% and 90% below 6%, many homeowners are reluctant to sell and take on higher mortgage rates HousingWire. This effect is expected to suppress home sales and limit inventory growth in 2025.

Despite these challenges, there are positive signs for the mortgage market. The Federal Reserve’s recent rate cuts and projected future cuts could indirectly influence mortgage rate declines Forbes. Additionally, the anticipated wage growth outpacing home price appreciation could provide some relief to potential homebuyers, potentially stimulating mortgage demand.

Commercial Real Estate Markets (including Multifamily)

The commercial real estate market in 2025 is facing significant challenges, particularly in the office sector. According to a Bloomberg report, 2025 is being viewed as a “year of reckoning” for commercial real estate, especially for office properties Bloomberg. The ongoing shift towards remote and hybrid work models continues to impact office occupancy rates and valuations.

Tim Mooney, head of real estate at Värde Partners, stated, “I look at 2025 as a year of reckoning. Lenders and borrowers will acknowledge that lower interest rates aren’t going to save them” Bloomberg. This sentiment reflects the growing realization that the commercial real estate sector, particularly office properties, may need to undergo significant restructuring and repricing.

The multifamily sector, while more resilient than office properties, is also facing challenges. Fannie Mae predicts that multifamily housing will “remain in a holding pattern” in 2025Fannie Mae. The sector is grappling with increased operating costs and declining rent growth, which have led to a rise in delinquency rates since August 2024 Bisnow.

However, there are some bright spots in the commercial real estate landscape. New home sales are expected to remain a positive aspect of the market, particularly in areas where land is available for development Fannie Mae. Additionally, some experts anticipate that 2025 could mark the beginning of a recovery phase for commercial real estate, as the market adjusts to new realities and reprices assets accordingly.

CMBS/REIT Markets

The Commercial Mortgage-Backed Securities (CMBS) and Real Estate Investment Trust (REIT) markets are closely tied to the performance of the broader commercial real estate sector, and as such, are expected to face challenges in 2025. However, these markets may also present opportunities for investors as the real estate landscape evolves.

In the CMBS market, delinquencies have accelerated in recent months, with the office delinquency rate reaching 11.2% in November 2024, which is three times higher than at the start of 2023 Bisnow. This trend is expected to continue into 2025, with Moody’s projecting that office delinquencies will peak above 14% in 2025 before moderating.

The “extend-and-pretend” strategy, where lenders and borrowers delay addressing problematic loans in hopes of market improvement, is becoming less viable. Glenn Grimaldi, CEO of Naftali Credit Partners, noted, “Even institutional, great household names have hit the end of their rope. The bank is hitting the end of its rope too, it’s ready to take the asset back” Bisnow. This shift could lead to increased distressed asset sales and potential opportunities for investors in the CMBS market.

For REITs, the outlook for 2025 is mixed. While office REITs are likely to continue facing challenges due to the ongoing transformation of work patterns, other sectors such as industrial, data center, and certain retail REITs may perform better. The potential for lower interest rates in 2025, as indicated by the Federal Reserve’s recent actions and projections, could provide some support to REIT valuations CNBC.

However, REITs will need to navigate carefully through the evolving real estate landscape. The repricing of commercial real estate assets, particularly in the office sector, could impact REIT portfolios and valuations. On the other hand, REITs with strong balance sheets and diversified portfolios may be well-positioned to capitalize on potential distressed asset opportunities that may arise in 2025.

The Bottom Line: Navigating Uncertainty in 2025

As we look ahead to 2025, the real estate market presents a complex picture of challenges and opportunities. While the residential market shows signs of modest recovery, affordability issues and regional disparities will continue to shape the landscape. The commercial real estate sector, particularly office properties, faces a potential reckoning, which will have ripple effects on CMBS and REIT markets.

For investors and industry professionals, the key to success in 2025 will be adaptability and careful analysis of local market conditions. As Lawrence Yun, NAR’s Chief Economist, emphasized, “the homebuying experience — as the adage goes — will continue to be a local one” Fannie Mae. This principle applies equally to commercial real estate and REIT investments.

The potential for lower interest rates and wage growth outpacing home price appreciation offers some optimism for the market. However, ongoing economic uncertainties, including inflation concerns and geopolitical tensions, could lead to volatility in both the residential and commercial real estate sectors.

As we navigate through 2025, staying informed about market trends, being prepared for potential distressed asset opportunities, and maintaining a long-term perspective will be crucial for success in this evolving real estate landscape.