PODCAST: ‘Not your typical cycle’: commercial real estate in 2025

Here's the cleaned-up transcript with speaker names in bold:

James Cook: For a while now, the commercial real estate industry has been telling itself it just has to survive until 25. Well, we're in 2025 and we're stepping into a landscape that's unlike anything we've seen before.

Brian Klinksiek: One of the common critiques of the skill set and knowledge base within our investment organizations and real estate is, "Oh, our younger people haven't lived through a downturn before through a cycle." And I say there are patterns that you see between different cycles, but to some extent, if you see one cycle you've seen one cycle. And if you apply prior easing cycles and policy rates to this one, you will draw the wrong conclusions. We have a totally different scenario today and one of the pieces of our outlook for 25 is that this will be a relatively good vintage for new real estate investment.

James Cook: That's Brian Klinksiek, global head of research and strategy for LaSalle Investment Management. LaSalle is the investment management arm of JLL with about 80 billion assets globally. Today, Brian joins me along with JLL's global chief research officer Ben Breslau, to talk about the realities of this new landscape. From interest rates to office trends, we're going to analyze the key drivers of today's market and their implications for the future of commercial real estate.

This is Trends and Insights: The Future of Commercial Real Estate. My name is James Cook, and I am a researcher for JLL.

I've read Brian, some research that your team produced that said we're at the dawn of a new cycle. Is that the same cycle or are we talking about two different cycles here?

Brian Klinksiek: There's lots of cycles in real estate. A wise person in our industry said capital markets are global, but property markets are local. I think that even capital markets aren't fully global. There are parts of the world that we've had to carve out of our outlook significantly because their capital markets are operating in a very different cycle or even in an acyclical fashion. You have Japan a gradual tightening pace, you have China experiencing a sort of generational weakness and the long-term direction is loosening, but when we say the dawn of a new cycle, okay we're generalizing.

If you look at the major developed markets, what we see is a turn from several years of repricing of transaction markets lagging the bond markets needing to catch up to them. But poor sentiment of investors, their lenders delaying action, delaying decision to an environment where while interest rates have drifted up, they're just not quite as volatile as they were in that earlier period.

That less volatility helps deals get done. We have more clarity that the economy is doing okay that's helpful. Having avoided a recession in the U.S. over the last several years was by no means a foregone conclusion, giving the history of tightening cycles particularly of this speed magnitude.

I think what we have is a return to an environment where you will have more clarity on price and value transaction markets more aligned with valuations in funds in valuations that lenders do. So just like more general alignment that enables stuff to get done, that enables capital to have clarity in entering and exiting investment vehicles that are valuation based that adjustment process is over.

And also just having more clarity on some of the big structural uncertainties around sectors like office. I think that one of the things that's helping sentiment is that the new normal has really come into focus and seems more stable. There's not one cycle. There's many we're simplifying there, but what we do see is, we don't need dramatic cuts in interest rates like we had in the GFC. Okay. To sustain a new investment cycle and renewed confidence.

James Cook: Ben, you've got researchers all around the world. A lot of them are focused on office, right? So I get the feeling that there's not a single office story. Is it fair to say the performance of the office market is quite dependent on the country and city that we're talking about?

Ben Breslau: That's definitely fair to say. And additionally, I would say that it depends which office building, even within a country or a city you're talking about. The dominant trend in offices that has created the dislocation that sort of Brian was referring to was the post-COVID kind of work from home alongside a real reckoning in the capital intensity of offices as an investment class within real estate and the changing the cost of capital had a, maybe an outsized impact on offices because of those things. And then the supply and demand of capital for offices, but that story played out in different ways around the world, because of how financing markets work around the world.

And also because of the differential of the work from home phenomenon during COVID and post-COVID. In Asia and parts of Europe, we saw people coming back to the office quite quickly after the pandemic subsided, obviously, in the U.S. It was much slower, but one of the things that's giving us optimism looking into the rest of 2025 and beyond is we have seen some of those trends return closer to normal and or stabilize. So we've seen some corporate mandates as an example for office occupancy and office attendance increasing across industries across cities. There's still quite a bit for companies to figure out in terms of their workplace of the future, but we've seen a commitment to people being together to collaborate to innovate to solve complex client problems to develop people in their careers. And we've seen that have a direct impact on demand for offices in some of those places that were lagging.

The other phenomenon, however, that's happening within office that's important to remember, and I think will continue through this year is the flight to quality and the differential and performance within offices, even within a given city. And that is fairly consistent, actually, all around the world for a number of reasons where high quality, modern, sustainable, located modern designed office assets are full or close to full and in high demand. Undersupplied and performing quite well while the lower quality and even the kind of commodity middle segment of the office market, which has been struggling is likely very much to continue to struggle because of its positioning in the market and the lack of capital to reposition it to be truly competitive.

Brian Klinksiek: I 100 percent agree with that observation. I think from the investors perspective, though, you have to make sure that you also look at how a factor like quality is priced. Ben referenced the fact that this isn't only about work from home. It's also about I think the word you use was a reckoning around the capital intensity of offices.

I think that offices were really overpriced for a long period of time, even before the pandemic. And an assumption that a good quality office building with fully leased on long leases with a good new modern lobby and elevators that building would be perfect and it wouldn't require a ton of capex to keep it competitive and keep it full over the long run. And, that is totally contrary to the operating history of offices, particularly in the U.S. which has been a structurally more tenant friendly market long before we were donning masks during COVID.

So while the occupier trends and the demand definitely favors that top quality building, and we're engaged in a number of strategies to manufacture those top quality buildings from weaker quality buildings, because that's where the demand is and that's where the capital, both in the capital market side and the occupier side. I think it does present a risk. This narrative presents a risk that part of the market will be priced to perfection, just like a broader swath of the office market was historically. I don't think we're quite there yet to make that kind of statement, you have to be careful as an investor to not only see the trend of that's in demand, that's good. There's a lot of rent growth in that thing without bringing in the factor of price. And, that's the kind of the extra lens that I would add to that.

Ben Breslau: And part of why we're focused on the pure supply and demand side of it is because we're also working with many occupier clients who are trying to secure space in those high quality buildings that are in short supply, despite the headline vacancy rates that they're looking at in some places that would make them think they're going to get the deal of the century in upgrading their offices, and so that dynamic is one that is surprising, actually, to some occupiers and it is, I think, positive for the market overall that the portions of the office market are stabilizing and improving and that there is some institutional capital coming back into the office sector and that financing has opened up for segments of the office sector that there'll be a positive flow from that materializing into other areas as well.

James Cook: Brian, you've got the whole world to look at you've got so many different property types. How do you determine where to invest? What's the method there?

Brian Klinksiek: So the core of our approach is around fair value. It's what is the required return for given investment proposition and what is the expected return? And what goes into those assumptions that analysis is not all highly observable or highly scientific. It's a mix. On the required return side, we look at the bond markets. We talked about bond markets earlier and what they're saying is the building block, but then you have to apply risk premia to that for real estate and for individual real estate sectors. And there's an art and a science to that. Some folks say that putting numbers to all of these things is an exercise that is insufficiently scientific because a lot of this is not observable. It requires educated guesses, but our approach is really based on the idea that numbers is a language to communicate our views.

A lot of investors say, I like that. I like that. It's a good piece of real estate or I like that market. That's a good market. But how much do you like that market? What is the risk involved investing in that market? Is it more or less than somewhere else? The darling sector today is of course, data centers. The expected returns in data centers are clearly high today, particularly if you're creating data center product. I think that there's not a lot of discussion around the required return for data centers. How do you price the technological risks and potential changes to things that really shaped the supply of data centers like power availability and that discussion's not being had. Our approach is really based on trying to come up with both an assessment of what you need in terms of return and what you're going to get. The relationship between those two numbers is a sort of key for us identifying things that look cheap, things that look fairly priced and things that look expensive.

James Cook: That sounds very simple. When you explain it that way, I'm like, of course, yeah that's how you should choose your investments. That makes sense. Okay. You mentioned data centers. I feel like that's one of the property types that's probably going to be in the most demand globally. Ben, I guess we talked about what would you call it? Like trophy office. Those are probably in demand. Is there anything else that we think there's going to be supply shortages for in terms of commercial real estate in the coming year?

Ben Breslau: I think in the coming year, the markets are rebalancing in a lot of places. But if you look out over a few year horizon, I think we are going to get to a point where we see supply shortages in many sectors and many geographies, but not all for the same reasons. So in a sector like office, especially in the West, where the broad sense is that there are demand challenges, which is true in the overall market. You're seeing new development shut down. There's no financing for new office development. Generally, there's not a lot of capital looking to get into new office development. There are a lot of legacy issues in office portfolios.

So you're seeing an almost collapse of the supply pipeline. And as the best stuff fills up, as I mentioned before, and then coming years, you're going to have real scarcity of high quality office that's available, which will create opportunities and challenges for occupiers opportunities for investors.

You have industrial supply pipelines, given some reset of supply and demand balance there that are also coming down quickly. Probably not as quickly as offices, but in the US and in Europe, we've seen industrial supply pipelines dropped by almost 50%. And so you have potential similar issue there in the living sector.

Certainly in the U.S. there's the opposite. Maybe some oversupply still in some places, but again, it depends where you look and that could be an interesting entry point as well. And then you look at some parts of Asia in general, where growth remains more robust, like in India, for example, where there is demand still outweighing supply across many sectors including offices and industrial and manufacturing and housing and then data centers is maybe the extreme example of that, where you have high supply, but even higher demand and also, as Brian mentioned this layer of technological change and also specialized requirement in terms of location and power and other issues to try to get new supply to the market. We are going to see in the coming two, three years, supply shortages in many areas of real estate, but not all for the same reasons depending upon where you look.

James Cook: Brian, I know you recently released your kind of big outlook report from LaSalle and have recommendations all around the world. What would be some of the highlights of your recommendations for 2025 in terms of geography and property type?

Brian Klinksiek: Let me start at a very high level we see a pretty balanced appeal between North America and Europe, but for very different reasons. The U.S. has great growth, and it has a lot of different investable sectors which creates a really fantastic menu of investment options for diversification.

But the U.S. is in the short term dealing with supply. We totally agree with Ben that supply is falling and the simple mathematics of development in terms of the financial math don't really work in many cases. So you need rents to rise in order to get supply again, but they're still digesting the supply of the last couple of years that we talk about in our report, a hangover from the kind of 2021 period where the world was reopening and money was cheap and a lot of shovels went into the ground and built a lot of product. That hangover is something the U.S. market's dealing with.

Europe, on the other hand, has really quite weak economic growth with the exception of some countries like Spain, which are doing very well, but doesn't have the supply issue. The story in Europe is about not having really had that boom in supply, having shortages of the right kind of product in the right locations, not having the same degree of dislocation from the office hit from work from home. And so the appeal there is much more about what's happening in certain cities and sectors. That has to do with supply and demand rather than just the big writ large dynamism of the U.S. economy, which is really what's carrying the globe today.

And then in terms of some specific calls that I would highlight we love in the U.S. industrial outdoor storage. It's less expensive, hard to access, but hard to recreate as well because a lot of municipalities don't want these pieces of land with a bunch of ugly trucks parked on them. They'd rather have a nice, tidy building that employs people if they want that at all. So there's a general backlash towards logistics uses and an NIMBY way in many markets that will constrain supply over the long run. But this IOS is a top call for us in the US.

And then one I'll highlight from Europe is some of the more creative sub-sectors of living that address shortages there's a sweet spot of providing the sort of 20 something housing. It's late student accommodation, early professional years. There's product in some markets that's a blend of that. That's really hard to come by, regulation of rents, rent control in many European markets means that the broader rental housing market there is basically hard to access for young people.

Asia, it's really a tale of three cities, not two, which is Japan, China, and then the rest and Japan is gradual increases in interest rates, but more of a normalization to a kind of post deflationary world there. We're generally seeing a continuation of a lot of the strategies that we've been pursuing for a while there around logistics offices and residential China, which is very weak and very difficult market today and then the rest, which it has to be more situational and opportunistic because there's still repricing underway in many of those markets.

What you can benefit from is the fact that like Seoul, which is one of the strongest office markets on the planet. You can play selectively in a market like that in office in a way that's very difficult and other parts of the world. It's about urbanization and the rise of alternative sectors and living. That will all happen in Asia as well and be the kind of cornerstone of strategy there in the kind of medium to long run.

James Cook: Ben, your team recently released a sort of roundup of predictions for the coming year. What's a highlight for you? What's a prediction that you're going to bet on?

Ben Breslau: A couple things. One is that the corporate sector, the occupiers we work with are starting to get more conviction about their real estate portfolios. They're in better shape to make decisions. Although we highlighted there still is some uncertainty out there. We have passed over some of the elections. Obviously we're still awaiting some of the policy decisions, but at least the overall direction from a kind of industrial perspective and trade perspective and policy perspective, tax and regulation is starting to play out a little bit more clear and that combined with the stabilization and kind of the workplace scene and the demand that there is for corporates to figure out their supply chains, figure out their data center options and all of those other parts of their portfolio we are seeing them lean in, make more decisions, be more strategic, think a little bit longer term, and actually, they're telling us over 50 percent of occupiers in a survey we did recently said, we're expecting our footprint footprint to grow in the coming year.

One thing we think is that the occupier side, it'll be inconsistent, just like the core real estate side, but it's going to get back to growth. The other thing we think is that we will see the transaction markets pick up across leasing and capital markets in 2025, to some extent. An indicator we look at on the capital market side is something we call the bid intensity index. Brian knows this one well, where we're actually looking at real time actual bid data for transactions in the private real estate markets to gauge liquidity through a number of different metrics. And we've seen improvement there after A trough coming from the whole rising interest rate environment. And some of the dislocation we talked about over the course of 2024 that has continued and remain steady toward the end of 2024, and that has proven to be somewhat of a leading indicator for us. And we are seeing unlike previous bouts of interest rate volatility, investors the course and underwrite through this volatility that we're seeing and some of the uncertainty we're seeing right now on the interest rate front.

So we think that's a good sign for transaction markets. And then I would say just in terms of places to watch another call out I might make is some of the growth sectors that are maybe a little harder to penetrate because they're not as Mature as some of the countries we've looked at. But India, as I mentioned before, Saudi and U. A. E. In the Middle East are examples of places where we see pretty robust growth and transformation and also accompanied by an improvement in transparency on the real estate data side. And we learned that from a great collaboration between Brian's team and our team on our recent real estate transparency index.

So those are among the top improving markets for real estate transparency. And we have seen capital generally flow to markets that have improving and high transparency. So those are a couple of things we're watching for 2025. The other thing we're looking at through transparency lens and otherwise is established sectors in maybe emerging markets or set another way sectors that may be mature and very well understood and very popular in some markets, but less transparent. Less harder to access in other markets. So an example would be just the living sector, the residential sector, where in the US, there is a very deep, very mature, very established very transparent and liquid market for residential housing. Investment, but in many other markets, both emerging and even some other established markets, there are lots of people that live in lots of buildings, but there is not the same level of maturity, sophistication and transparency for investors to be able to invest at scale in the living sector, which has generally speaking, good. Tailwind in most markets. So that's an example of maybe established sectors, but in new markets.

James Cook: Fantastic. We're just about out of time. Brian, Ben, whatever happens I'm sure it's going to be exciting. My only prediction for the coming year is that I will be surprised regularly because surprising things just keep happening. Thank you so much for joining me today.

This has been a fabulous discussion. I really appreciate it.

Ben Breslau: Thanks, James.

Brian Klinksiek: Thank you.