The combination of limited new supply and strong demand, driven by a still tight labor market, suggests that asset owners may gain increased pricing power and benefit from rising rents over time.
Higher interest rates are generally seen as a headwind for real estate. Academically, higher interest rates reduce the present value of future cashflows. Practically, higher interest rates disincentivize investors from committing to long-term investments like real estate when cash yields are relatively high. As we look forward, a number of factors are likely to keep interest rates relatively high for the foreseeable future: higher inflation as tariffs begin to raise prices, the ballooning U.S. fiscal deficit, and rising geopolitical risks. But all is not lost for real estate investors. While initially a headwind, persistently higher rates can reduce the amount of supply in the market and create a favorable environment for real estate investors.
We can consider this as three distinct phases.
Phase 1: Repricing, largely completed
A significant re-pricing of real estate began in 2022, and in some sectors, continued through 2024, following the most aggressive Fed hiking cycle since the 1980s. Commercial real estate (CRE) valuations declined by over 20% on average. Office was hit the hardest due to the combined impact of higher interest rates and the COVID-era shift to hybrid work.
What makes the post-COVID repricing unique is that net operating income (NOI) – rents, less operating expenses – grew during the correction. In prior real estate downturns, declines in valuation came alongside falling income.
The repricing appears to be largely complete, with aggregate CRE property prices inching higher at the beginning of 2025.
Phase 2: Supply shock, as higher interest rates crimp the ability to build
High interest rates are severely limiting new construction. Across office, industrial, multifamily and retail sectors, construction starts have decreased by approximately 75% on average compared to their peak levels over the past five years. Office development has dropped by 83%, while multifamily construction is down by 70%.
The supply constraints, alongside historically high single-family property prices and relatively high mortgage rates, have made the American Dream of home ownership elusive.
The combination of limited new supply and strong demand, driven by a still tight labor market, suggests that asset owners may gain increased pricing power and benefit from rising rents over time.
Phase 3: Increasing dispersion by asset quality
Looking ahead, we expect the next chapter will be marked by growing dispersion across real estate sectors and asset quality. The zero-rate era that followed the Global Financial Crisis was a “rising tide” that lifted nearly all asset prices. That period is behind us. For example, in the office market, 10% of buildings account for 60% of total vacancies. Meanwhile, 40% of all office buildings have a negligible vacancy rate. Going forward, capital will likely flow to the highest-quality properties and managers, while lower-quality assets could continue to struggle.
Investment implications
Higher-for-longer interest rates have created dislocation, but also opportunity. With repricing behind us and supply constraints starting to be felt, this may be an opportune moment to own real estate. But selectivity matters: in today’s environment, owning the right assets — not just any assets — will be critical.