The Quiet Recovery: Why This Commercial Real Estate Cycle Rewards Old-Fashioned Skill

US commercial property values spent roughly two years adjusting downward and finished about 20% below their peak. What makes that decline unusual is what was missing from it. The economy never went into recession. By that measure, this is the first sustained downturn in US property values that happened without an economic contraction, and that changes how owners and investors should think about the recovery now underway.

To understand where we stand in the cycle and what to expect next, I recently welcomed Mike Acton, CFA, Managing Director and Head of Research & Strategy, North America at AEW Capital Management, to America’s Commercial Real Estate Show. Mike helped found AEW Research in 1990.

For owners and investors, his read carries a practical message. The recovery is real, it is likely to run longer than many expect, and the returns will go to people who operate well.

A First in US History: Values Fell Without a Recession

Mike’s view is that the market has passed the bottom and sits at the very beginning of the next up cycle in property values. Because values fell without a recession, they are now recovering without the kind of broad economic rebound that usually lifts all property at once. Most major property sectors are behaving the way late-cycle sectors behave, with similar and modest outlooks for net operating income (NOI) growth.

As Mike tells his investors, when something happens for the first time, take note of it. A market that broke pattern on the way down will likely break it on the way up as well.

Income Will Carry the Returns, and the Runway Is Long

The data already shows the shape of this recovery. According to Mike, the market has posted 8 consecutive quarters of positive total return, but only 6 quarters of capital value growth, and those increases have been very small and uneven.

• Income-Led Returns: Through at least next year, Mike expects nearly all total return to come from income, with aggregate capital appreciation arriving later.
• Lower IRR, Higher Multiple: Investors should plan for lower internal rates of return in aggregate, offset by a likely higher equity multiple across the full holding period.
• Scarce New Supply: Construction usually ends real estate recoveries. Today it is hard to build, with higher interest rates, higher costs, and labor and materials being absorbed by the AI capital spending cycle. Limited supply gives this recovery a longer runway.
• Transaction Volume: Sales activity is running near the 2018 and 2019 pace. Mike does not expect a return to the 2021 and 2022 levels, which were driven by near-zero rates and heavy federal stimulus, anytime soon.

I agree on supply in particular. Constrained new construction is one of the strongest supports for existing owners in this cycle.

Rates, Oil, and the Capital Coming Home

Mike was candid about rates. Higher oil prices since February have fed into inflation and inflation expectations, and the 10-year Treasury sits near 5%. Six months ago the market expected the Federal Reserve to cut. AEW is now planning for the next move in rates to be up before it is down.

At the same time, capital continues to flow toward US property. Reshoring, which began with the CHIPS Act and continues today, is bringing production back to the US, and foreign investors are turning back to US commercial property as well. Mike cited former Citicorp chairman Walter Wriston: capital goes where it is most welcome and stays where it is best treated.

The allocation math helps too. Target allocations to real estate have held steady at roughly 10% to 15% for many institutions, but stock market gains have grown the total portfolio. A fixed percentage of a larger pool means more absolute dollars must go into real estate just to stay on target. Mike also sees money returning to core strategies, which keeps the whole ecosystem healthy.

The Sector Standouts: Senior Housing and Retail

While most sectors share a similar NOI outlook, Mike pointed to two that stand apart.

• Senior Housing Demographics: AEW has invested in seniors housing for about 30 years. The first baby boomers, born in 1946, turn 80 this year. About 50% more Americans were born in 1946 than in 1945, so the population just turning 80 is roughly 40% larger than the population turning 81. That wave moves up one age cohort every year.
• Senior Housing Operations: This is an operating business. AEW works with a stable of best-in-class operating partners, and the executive director at each property is critical to its success.
• Retail Recovery: Retail spent more than 10 years with almost no new construction after the iPhone changed how Americans shop in 2007. Total retail stock declined and the strongest retailers mastered multichannel fulfillment, setting up a broad recovery.

On senior housing, my own practice matches Mike’s caution. When investors who have never owned the property type ask us about it, I spend the first 20 minutes trying to talk them out of it. If I cannot, the next conversation is about finding the right operating partner.

Office, CapEx, and the Return of Old-Fashioned Real Estate Skill

The office recovery is real but highly selective. The right buildings are doing extremely well, and Mike expects the gap with the rest to widen over the next few years.

His prescription applies to every sector: pick the right property, keep it leased, control expenses, and be disciplined about capital expenditures and the eventual sale. As he put it, do not renovate a lobby because it looks nice. Do it because it gets you a better tenant with better credit at a better rent.

I had a multifamily client years ago who was adding decks and privacy fences across his properties. When I asked how much the improvements would raise his rents, he thought about it and admitted, not much. Every dollar of capital needs to earn its way into the rent roll.

Data Centers and the Obsolescence Question

Data centers draw enormous attention and capital, and AEW is not currently an active investor. Mike’s concern is obsolescence, which he believes is accelerating across the economy. A single data center could become uncompetitive quickly with small changes in technology. AEW may revisit once stabilized assets trade regularly.

Final Thoughts: Keep the Insurance in Place

Mike closed with a history lesson. In the late 1990s, investors listened politely to the real estate story but were fixated on technology stocks. From 1997 to 2000, property posted solid total returns while stocks dwarfed them. From 2000 to 2003, real estate kept the same pace with yields around 7%, while the stock market fell 40%. Suddenly everyone wanted to talk about property again.

Today, much of the economy is levered to AI. Real estate offers diversification, durable income, and a measure of inflation protection, qualities that feel unexciting right up until they matter. You do not wait until the house is on fire to buy insurance. Investors who keep their allocation and focus on operating fundamentals are well positioned for a long, income-driven recovery.

Have a Commercial Real Estate Strategy to Discuss?

How do you see the recovery? Some investors see this as a great time to buy; the acquisition window of opportunity is open longer in this cycle. We are experiencing good activity on properties we take to market. If you would like to discuss the market and your goals, give me a call.

Michael Bull, CCIM
Michael@BullRealty.com
404-876-1640 x 101