By Tim Storey
With the new administration and aligned congress taking the helm in Washington D.C., change is in the air moving into 2025. Economic policy and priorities are shifting, and we are all in a wait and see mode as the year unfolds. Arizona entered 2025 with a healthy economy from strength in technology, manufacturing and the service sectors. Tucson, for its part, has enjoyed wage growth, low unemployment, and population growth supporting local fundamentals. Strengths in healthcare, aerospace, technology, and education should continue to define the health of the local economy.
Nationally and locally, commercial real estate has adapted to what many are calling a higher for longer rate environment after a decade-long run of ultra-low rates. Current rates are not in the range of historic highs, although they feel that way for anyone navigating maturing debt or new investments in this current range. Sill, debt liquidity from diverse sources remains very accessible to commercial real estate.
Rates: While the Federal Reserve delivered a full 100 basis points of rate cuts at the close of 2024, we have seen a converse rise of the 10-year treasury yield. Treasuries are far more aligned with CRE borrowing. Absent signs of increasing inflation or a slowdown in employment, only two cuts are expected in ’25. However, for CRE what happens with the 10-year treasury will have a far greater impact on rates.
On that note, the market continues to evaluate what to expect from the new Administration; with uncertainty surrounding tax cuts, new tariffs and the potential increase in the Federal deficit contributing to a weakening bond market. Last year, the Fed focused on quantitative tightening and China shifted its attention to the purchase of gold and became a net seller of U.S. treasuries. These forces are contributing to rising treasury yields.
Immigration and Border Policy: A disruptive variable for 2025 is exactly how new policies on immigration and tariffs will affect Arizona’s border economy. Potential impacts on labor supply and costs could be a drag on growth and new development in both the commercial and residential real estate markets.
Investments: With expectations that Treasuries will stay in the mid to high fours with potential to push into the low to mid fives, we should expect fixed rate loans in the high fives into the sixes. This will impact debt service, cap rates and values as transactions are negotiated. The real question is: will sellers and buyers be able to bridge the gap on pricing expectations? Maturing debt will compel decisions for owners, as will cap rates for buyers.
Banks: Most banks have been sidelined since the beginning of rate volatility in 2022. As they shore up their balance sheets and process through existing challenged loans, they are starting to return to the marketplace. But until we see a dramatic increase in bank liquidity, we should expect that they will remain very selective with respect to sponsor qualifications and target asset classes.
Life Companies: This consistent source of permanent financing has remained active in the absence of banks in the current cycle. Expectation is they will remain active in 2025; with spreads to compress very slightly in the first quarter then widen as activity increases. In an era of ongoing rate volatility, their non-recourse terms and willingness to lock rate at application will remain attractive.
Asset Classes: Lenders across the board are prioritizing allocations to multifamily, industrial, self-storage, and neighborhood or grocery anchored retail. Options for hospitality and office exist in a case-by-case basis but are far more challenging in the current market.
Multifamily: The Tucson market supply continues to outpace demand, with vacancy up slightly at the end of last year, and rents remaining relatively flat. That being said, a strong local economy including wage growth and low unemployment continues to support the desired fundamentals for refinancing maturing debt and location-driven new development.
Industrial: New development continues in Tucson for spaces in the 100,000-square-foot-plus range. Current vacancies at 5% to 6% are keeping fundamentals healthy. Most new construction is occurring in the large to mid bay format. Smaller bay properties are seeing tighter vacancies, but rents are not there yet to warrant new development at current costs.
Retail: This asset class has been a strong performer, especially neighborhood and grocery anchored retail. Impacts from store closures and corporate reorganizations is yet be seen. Will departures of retailers like Party City, Container Store, Macy’s, Big Lots, Walgreen’s, and CVS create new opportunities for growing retailers like Aldi, TJ Maxx, Marshalls and Home Goods? We will see.
Office: Major companies continue to mandate return to office; will this lead to improvement in certain office markets? It should help buoy the best properties out there, but office is in an era of transformation, and we should expect the pain in this sector to continue in 2025.
Construction: Construction dollars are available from banks (selectively), life companies and debt funds. However, increasing materials, labor, and entitlement costs have dramatically increased projects costs in a higher rate climate. Where there is demand to meet the necessary yields, ready financing options are available.
Tim Storey is a Principal in Gantry’s Phoenix office. He focuses on the origination of both debt and equity working with insurance companies, banks, CMBS, and other financial institutions to obtain optimal financing solutions for his clientele.