The window for buying commercial property on the cheap is rapidly closing, and has already slammed shut in some markets. With valuations holding firm and rate relief slipping further out of reach as bond yields climb, analysts say the next phase of the cycle will reward operators, not opportunists.

A more subdued outlook on interest rates and widely available debt have shifted capital markets from a bargain-hunting exercise to one where value is unlocked by the budget line item. Across midyear reports from a range of analysts and experts, a common theme has emerged: In a volatile rate world, improving net operating income is the primary path to increasing value.

“We've had a number of conversations with investors who have been really focusing on how to operate the property in the best way to generate that NOI,” Lauro Ferroni, who leads capital markets research for the Americas at JLL, said in a recent interview. 

It’s a sentiment echoed in analyses from UBS, Principal Asset Management, Newmark and others.

“Increasingly, the differentiator between winners and losers is earnings delivery rather than valuation recovery,” UBS analysts wrote in its midyear Global Real Estate Analyser report. Prices have largely reset, and performing assets are getting an added tailwind from the steep drop-off in commercial construction in recent years. 

Cap rate compression is unlikely, especially in a higher interest rate environment, and owners are going to have to shift their books to continue growing asset values, Principal Asset Management analysts wrote in its midyear Global CRE Outlook. 

“Investors may have forgotten how much income returns matter,” Rich Hill, Principal’s global head of research and strategy, wrote in the report. 

Historically, income drives roughly 85% of total returns over the course of a cycle, according to the report.

Cap rate stagnation is by far the most likely outcome for the next six months, according to a recent survey from CBRE that showed the share of investors that believe cap rates will compress has declined significantly from last year.

Sales data suggest that commercial real estate is broadly in the early recovery phase. Distress exists, but deeply discounted sales are being held off by widely available capital and lenders that are still willing to creatively extend loans so long as landlords bring cash to the table.

U.S. transaction volume in the first half of the year was up 31% year-over-year to $293B, the strongest first half to a year since 2022, thanks in part to a rebound in trades for over $250M, according to Newmark. Deal volume was up across every real asset class, and REIT acquisitions were up 86% from the prior year. 

Debt origination was up 25% year-over-year, but the capital is being put to work more often to refinance debt than make a trade. Its wide availability has kept the cost of capital from rising significantly even as yields on the 10-year Treasury, a key benchmark for underwriting, continue to march higher, Ferroni said. 

Commercial real estate prices were up roughly 20 basis points compared to last year in July, according to MSCI, despite the 10-year Treasury rising by roughly 50 basis points since the start of the year. 

“It's just that wall of capital is what's keeping pricing firm and, in some cases, pricing increasing somewhat, even in the face of some of the macro volatility,” Ferroni said.

Apartment landlords are starting to see rent growth after relying heavily on concessions to keep and win tenants as occupancy stabilizes above 95% despite the continued delivery of a wave of new construction. Industrial leasing has ramped up compared to last year, and the best office towers have no vacancy, leaving businesses in the best-performing markets to start taking space in the next tier of properties. 

With core sectors largely performing, commercial mortgage markets are becoming increasingly competitive, and JLL Capital Markets CEO Richard Bloxam wrote in a recent analysis that the wide availability of debt was directly translating into more deals. 

Investors’ shifting view on interest rates and the macroeconomic environment is adding to the momentum. Billions of dollars were sidelined in recent years by the promise that the Federal Reserve would soon begin easing rates, but investors are now grappling with the opposite forecast. 

With inflation well above the Fed’s 2% target and a labor market that remains relatively stable, rate hikes are now the predominant theme among investors. Waiting for a better environment no longer looks like a viable option, but wide capital availability and creative workouts mean deeply discounted deals have become rarer after a wave of rock-bottom office sales in markets like Chicago. 

“The only likely path to rate cuts is one that comes with a slower economy and lower values, so sellers waiting to move on easier monetary policy are likely to be disappointed,” the Newmark analysts wrote. 

The prospect of looser monetary policy dimmed further in late August, when Kevin Warsh, the chairman of the Federal Reserve, gave a closely watched speech from Jackson Hole, Wyoming, where he unsuccessfully tried to tell markets not to react based on what the central bank says and immediately shifted Treasury markets. 

He also said current Fed rates weren’t broadly restrictive to capital markets, and futures traders and betting markets like Kalshi reacted by betting on or pricing in the higher likelihood of a rate hike when the central bank meets on Sept. 16. CME Group’s FedWatch also points toward a likely rate increase, showing a 68% likelihood for a quarter-point increase this month.

“Credit and loan markets are showing few signs of policy restraint,” Warsh said in the annual speech. “Certain sectors like housing and agriculture are showing strains, but on balance, I would be hard-pressed to describe broad financial conditions as restrictive.”