A year ago, Susan M. Wachter, Wharton professor of real estate and finance, had noted that while 2023 had been “extremely painful” for the real estate industry, the reigning theme for 2024 would be an easing of some of those pains but also waiting for better times. “Stay alive to ‘25,” advised Wachter, who is also co-director of the Penn Institute for Urban Research.
As it turned out, the real estate industry “just survived” in 2024, Wachter said in December on the Wharton Business Daily radio show on SiriusXM, where she shared her insights on the outlook for 2025. (Listen to the podcast.) She forecast “muddy waters ahead,” but noted that 2024 brought some happy tidings.
“The big surprise of 2024 is this incredible GDP growth on all cylinders,” she added, pointing to the Federal Reserve Bank of Atlanta’s GDPNow latest estimate, which she noted “is far higher than anticipated.”
On the flip side, that buoyancy in GDP growth is affecting demand across the board, inflation expectations, and expectations about rate decreases. Residential real estate is caught in the aftermath of those trends — it already faces a crisis of tight supply, with no respite immediately in sight.
The Specter of Mortgage Lock-ins
“Inflation has come back” along with strong economic growth, which in turn will affect the 10-year Treasury rate, “and the mortgage rate even more,” Wachter said of the latest estimates. As the 30-year mortgage rate stays high at 6.8%, households that have cheaper mortgages of 3%, 4%, or 5% prefer to stay put in their homes in the so-called mortgage lock-in effect.
A number of households have mortgage rates of less than 4%, Wachter noted, which means housing supply will stay constrained in the foreseeable future. But if the inflation rate declines sufficiently to warrant lower mortgage rates and make mortgage lock-in less attractive, supply could surge, she explained.
Home builders are trying hard to meet the supply gap, especially with more price-sensitive homes that match the market’s demand, Wachter said. In fact, the percentage of supply coming from new construction as a share of total purchases is at a high.
Prices of newly built homes are usually higher than those of existing homes, but that equation is also giving way to meet the market. “Housing prices are converging, which reflects the fact that home builders are building to demand,” she noted. They are doing this to overcome buyer resistance because prices are simply too high.
“[Revival of housing markets will] happen when we have the big picture issues dealt with, which are interest rates, mortgage rates and inflation expectations under control.”— Susan M. Wachter
Consequently, builders’ profit margins are down, which is made worse by higher input costs. “[Builders] are having a hard time getting affordable product [to market],” Wachter said. “But they’re trying to get affordable product out, and they’re doing a pretty good job of it.”
Home builders are incentivizing deals by offering financing at lower interest rates. “If interest rates and mortgage rates fall a bit more, they’ll be able to make more deals,” Wachter said.
Multifamily rentals are emerging as another solution to ease the challenges of housing supply and affordability. “In the rental market, supply is up such that we are seeing rent relief,” Wachter said. On average, rent levels are flat in newly built houses, and they have fallen in some markets in the Southeast; in places such as Austin, Texas, rental housing is seeing oversupply, she added.
But that situation could change over time. “The supply is more than sufficient right now, but the demand is so high that that supply may be absorbed in a year or two, and we’ll start seeing rents go up again,” Wachter predicted.
In the meantime, new rental housing supply, and flat or lower rent levels, are feeding into the CPI (consumer price index). “For the first time in a few years, we see a shelter component of CPI that’s less than the inflation rate, which is good news,” Wachter said, “because that was what was driving inflation.”
Even as those developments bring relief to the housing markets, the biggest challenge is to increase supply in the market for existing homes, which accounts for the bulk of housing transactions. “That’s going to happen when we have the big picture issues dealt with, which are interest rates, mortgage rates, and inflation expectations under control,” Wachter said. But getting those stars to align is no easy fix, and that solution might get pushed closer to 2026, she noted.
“[For commercial real estate], the good news is that the bad news may be bottoming.”— Susan M. Wachter
Relief for Commercial Real Estate
For commercial real estate, “the good news is that the bad news may be bottoming,” Wachter said. The capital markets are opening up, and deal flow, which has been zero, is coming back, she added. “REITs (or real estate investment trusts) have done quite well this year because [they are coming] off of a really bad bottom. Commercial real estate is still in a recession, but it’s coming back.” Helping that is the strong growth of the overall economy.
One big positive development for commercial real estate that Wachter noted is the recovery of banks from the 2023 regional banking crisis. Regional banks tend to have substantial exposure to real estate, and the 2023 crisis was “a potential systemic event” that nearly froze all new lending to construction and real estate.
Other developments are also helping cheer on commercial real estate. The current combination of short-term rates being lower with long-term rates up is “very bullish for banks,” Wachter continued. “That is good for real estate, because that means the debt market is open again, and we can see deals being made.”
Office markets are also seeing conversions to housing, which brings a degree of relief from the vacancies that occurred in the wake of COVID. Even as some office markets have vacancies upwards of 20%, overall economic growth is helping fuel fresh leasing activity in places like New York City for Class A office space, Wachter said.
“When we get [inflation] between 2% and 2.5%, we can see mortgage rates coming towards 5.5% or 6%…. That’s the best-case scenario.”— Susan M. Wachter
The days of remote/hybrid work are not over, but companies are optimizing their space needs and requiring workers to physically attend the office on more days of the week, she noted. “The remote work drain is, if anything, turning in the other direction.”
Inflation: Waiting for ‘Some More Good Numbers’
No one is betting that mortgage rates could go back to levels of 3% ever again. “[But] if all goes well, we could be at high fives at the end of 2025,” Wachter said. “That’s a hope. That’s not a prediction. But it’s possible.”
Getting there will call for “some more good numbers” on inflation, Wachter said, and pointed to some encouraging signs. “We’re at a very tentative moment here. It’s amazing how we have such extraordinary [economic] growth, and we haven’t really seen a resurgence of severe inflation. Even with this growth, there are some signs of easing, allowing for a slow decline in inflation.”
It is conceivable those trends will continue and gather strength. “This is the good picture that I’m drawing now: We could continue to see 3% plus [GDP] growth, and inflation heading from the 3% high point to closer to 2.5%,” Wachter said. “And when we get [inflation] between 2% and 2.5%, we can see mortgage rates coming towards 5.5% or 6%. That could happen. That’s the best-case scenario.”
All that said, Wachter was cautiously optimistic for 2025. “This year forward, I’ve never felt more of a sense [that] there are so many known unknowns.”
