Early Warnings of CRE Price Problems

The news cycle moves faster than data on performance in commercial real estate (CRE), with few current data points indicating trouble in the sector from tariff turmoil. U.S. deal volume was unchanged from last year in April and transaction cap rates saw little movement as well. The absence of evidence is not evidence of an absence of trouble, however.

The structures of the CRE market are simply slow moving, with some deals taking more than six months to close. The full pain from the turmoil, if any, is more likely to be seen in the third quarter of 2025. Even without direct signals of trouble, however, one can look to the performance of other indicators to model how CRE should perform in the face of shocks.  

A paper I co-authored in 2009 highlights the relationship between appraisal cap rates and the performance of other asset classes.¹ Cap rates are a measure used to gauge pricing in commercial property, essentially the inverse of a price-to-earnings ratio. Using the same framework to understand transaction cap rates, one can find signs of potential pricing problems.  

A common misunderstanding 

A key misconception on the part of many CRE investors is that cap rates move on a one-to-one basis with the 10-year US Treasury (UST). As shown in the chart below, this spread is not static. The spread narrows and widens based on other factors such as investor perceptions of risk, relative market liquidity and growth in property income. Some of these indicators are updated more frequently than quarterly updates of CRE performance data and can be used to model how pricing should respond to tariff turmoil.

RCA Hedonic Series cap rates. Data through Q1 2025. Source: Federal Reserve Bank of Saint Louis's FRED, MSCI Real Capital Analytics 

On risk, since the U.S. policies on tariffs were announced on April 2, the daily spread between the 10-year UST and Moody’s Baa corporate bond rate has increased 10 basis points (bps), though at the peak the increase was 30 bps. The increase from the start of the year is roughly 40 bps, as policy uncertainty has cast a cloud over the markets. Historically, for every 100-bp increase in the spread between corporate bonds and the UST, the office-cap-rate spread to the UST increased about 85 bps within a year, we estimate. 

Spread between 10-year US Treasury and Moody’s Baa corporate bond yield. Source: Source: Federal Reserve Bank of Saint Louis's FRED

There is potential for liquidity to dry up in certain quarters of commercial real estate as well. Speaking with industry professionals active in capital raising for fund management, there is talk of cross-border investors removing the U.S. from their target list of investments. The rationale varies, but at a fundamental level, if countries are prevented from exporting to the U.S., they will not have U.S. dollars to recycle into U.S.-dollar-denominated assets.  

Analysis using MSCI’s Capital Liquidity Scores shows a market is more liquid if cross-border investors are active, as these deep-pocketed investors tend to pay the lowest cap rates for deals. Indeed, as shown in the chart, across 54 office markets in the U.S., as liquidity falls relative to the long-run trend, cap rates rise. Cross-border investors accounted for 7.2% of all capital flowing into direct purchases of offices in the U.S. in 2024, so removing a chunk of this capital could hurt office pricing. In a potentially worrying sign, relative liquidity in the office market did nudge down slightly in the first quarter of 2025.  

Capital Liquidity Scores for 54 U.S. office markets, normalized for weighted deal volume and long-term trend. RCA Hedonic Series cap rates. Data through Q1 2025, as of May 29, 2025. 

As to property income, that can be tricky. The talk of a potential recession has increased, but office leases are long, and it may take some time for any negative shocks to be realized in income for such properties. Recession fears are driven by concerns over supply-chain realignments, higher inflation and less consumer spending. Such factors could reduce income for all property types. The hotel market is likely to exhibit income problems before any other commercial-property type however, as room rates reset daily. As such, one might look at trends in hotels as a bit of a canary in the coalmine. The fact that deal volume for hotels fell 52% from a year earlier in April should introduce a sense of caution for other sectors.  

Frustration after the pain 

Regardless of external factors, commercial real estate is still an opaque asset class, with information coming through slowly owing to the process around transactions. Industry professionals often gather information on the market simply by attending conferences and talking with other participants about challenges around deals underway. Talking with many of these professionals at conferences this spring, the attitude that I picked up was frustration in that many had endured a great deal of pain following the interest-rate shocks only to have the rug pulled out from under them. Current pricing metrics do not reflect this frustration, but the writing is on the wall.