Commercial real estate (CRE) is staging a comeback, but not the kind that lifts all boats to the same degree. After two years of price resets, the recovery now underway is broadening in form but not yet in force. REITs have rallied by roughly 35% from their 2023 lows, valuations across all four major indices appear to have troughed, and transaction volumes have risen year-over-year for six consecutive quarters. Yet distress, a lagging indicator, continues to edge higher.
This apparent contradiction captures the market’s complexity, as well as the opportunity. On the surface, the CRE cycle is following its historical script: public markets bottom first, followed by private valuations 12–18 months later and delinquencies roughly two years after. Beneath the surface, however, returns are diverging sharply across property types, geographies, and funds — exposing a market ripe for active alpha generation.
Investors are no longer confronting a downturn; they’re navigating a dispersion. And as the fog of adjustment clears, the path forward increasingly favors selectivity, income durability, and strategic conviction in the commercial real estate market.
The cycle turns unevenly
The data confirms that CRE is in recovery mode, with valuations improving across the four major indices, even though the rebound remains uneven:
- Green Street CPPI: +2.9% year-over-year as of September 2025, +6.3% above its trough.
- RCA / MSCI Index: +2.6% year-over-year, +2.8% above trough.
- CoStar Commercial Repeat-Sales Index: +1.7% above trough after rising in three of the past four months.
- NCREIF Property Index (NPI): Total returns +4.7% year-over-year, +5.6% above trough.
The differences are partly methodological. Green Street often serves as a leading indicator because it seeks to capture real-time property valuations based on ongoing market negotiations. In contrast, RCA and CoStar rely on repeat sales data, while NCREIF tracks appraisal-based values, which typically lag actual market movements.
The indices also reflect different peaks in valuations. For instance, during the Global Financial Crisis, the three price-based indices (Green Street, Costar and RCA) fell roughly 35%–37%. Yet CoStar rebounded 175%, outpacing Green Street (145%) and RCA (135%). It therefore stands to reason that Costar would fall the most and have the most uneven recovery.
Nonetheless, the indices collectively tell a consistent story: values have stabilized, and momentum is building. Still, headline indices can obscure as much as they reveal, and price trends vary widely across property types and markets. For investors, it depends more than ever on what and where they own.
The recovery is rewarding selectivity
In our 2025 Mid-Year Outlook: Back to Basics, we argued that this phase of the cycle would reward fundamentals, not financial engineering. That thesis is playing out in real time.
Headline returns tell one story: the NPI posted a +1.2% total return in 3Q25. But underneath, dispersion is widening dramatically. Across markets and subtypes, top-quartile performers returned between +2.1% and +10.1% (an annualized rate exceeding that of many public equities), while bottom-quartile assets ranged from -24.4% to +0.6%.
That spread underscores the importance of precision in both property and market selection. According to Green Street data, analyzing prices for each property type across major markets:
- Apartments and senior housing lead the recovery, with increases of +11% and +10% from their trough across the top 50 markets.
- Office and storage remain under pressure, with prices at their troughs in 3Q25. However, 19 of the top 50 office markets are experiencing price gains, and five are up by more than 3%.
- Market-level dispersion is equally pronounced: in every major property type except office and storage, prices in the top quartile of markets are up more than +10% from their trough.
This uneven tide isn’t a flaw of the recovery; it is the recovery. In an era where beta no longer dominates, the opportunity lies in identifying and owning the right assets in the right locations at the right moment.
Inside the core: Dispersion among institutional funds
The same pattern is evident in the core institutional universe. The NCREIF ODCE Index, a benchmark tracking 25 open-end funds invested in core U.S. real estate, posted total returns of +0.73% in 3Q25, down modestly from prior quarters but still positive. More tellingly, return dispersion has more than doubled to +2.03%, a level historically associated with major turning points in a market cycle.
One-year trailing results reveal a growing gap between winners and laggards. And while dispersion has always existed among open-end and closed-end funds, the drivers this cycle are distinct.
Trailing 1-year total returns for ODCE funds by quartile
| Quartile | 1st | 2nd | 3rd | 4th |
|---|---|---|---|---|
| Performance / Dispersion | +5.7% / 0.5% | +4.9% / 0.3% | +4.0% / -0.2% | +0.3% / 5.0% |
Source: NCREIF, Principal Asset Management, as of 3Q25.
Property election
For much of the past decade, performance was largely determined by sector exposure, with one sector in particular standing out. Industrial, buoyed by e-commerce and logistics demand, was the strongest primary sector performer since 2016 with a 12.2% annualized return. However, its leadership is moderating. Industrial now represents 34% of ODCE portfolios, and allocations across quartiles have converged near that level. The differentiation that once came from overweighting the sector is fading.
In contrast, retail has quietly become the standout. With annualized total returns of 7.3% since 2024, outpacing residential (+3.6%)
Alternative sectors
Income as the new alpha
The nature of return generation is shifting. From 2010–2019, income accounted for just 44% of the ODCE Index’s total annualized return of 11.4%, with appreciation doing the heavy lifting. Historically, however, income has contributed more than 80% of total returns over full cycles.
That balance is shifting back toward income. In a world where interest rates stay higher for longer and cap rate compression is limited, the steady cash flow a property generates is once again the main driver of returns. Funds that can consistently deliver more than 1% income per quarter are better positioned to produce reliable total returns. Those with weaker income streams will find it harder to keep pace as appreciation plays a smaller role.
Recent results hint at this transition: over the past year, top-quartile funds generated income returns of +4.2%, compared to +3.7% for the bottom quartile. The ability to sustain yield through occupancy, lease duration, and tenant credit quality is becoming the clearest differentiator of quality and/or performance.
The commercial real estate reset is unfolding largely as expected: valuations have largely bottomed, sentiment is improving, and activity is beginning to recover. Yet beneath the surface, dispersion is sharper than at any point since the Great Financial Crisis. The message is consistent across indices, property types, and funds. The CRE cycle has entered its next phase—one defined less by broad macro recovery and more by micro-level differentiation.
Implications for investors
Today’s opportunity lies in precision. Just as equity investors focus on selecting the best stocks in the best sectors to deliver alpha, so too should real estate investors focus on selecting the right property types in the right markets. Dispersion in fund returns now mirrors the spread between active and passive public equity performance. This isn’t a sign of fragility; it’s evidence of a functioning, selective market where fundamentals matter again.
Themes still matter in CRE, but they demand sharper focus. For instance, in residential, the challenge is less about undersupply and more about a mismatch between where housing is available and where demand exists. Data centers continue to benefit from secular tailwinds, though the most attractive opportunities lie in cloud and AI inference facilities rather than in more speculative generative AI projects. And while industrial remains vital to global infrastructure, the next cycle will likely favor modern, high-spec warehouses over broad exposure.
Finally, the return of income as the dominant driver of CRE returns marks a structural shift. With cap rate compression largely behind us, yield generation now depends on operational excellence – including cycle-tested occupancy, disciplined leverage, and sustainable cash flows. In this environment, income returns will likely distinguish top-quartile performance even more than appreciation potential.
Bottom line, the next chapter of CRE returns will be written not by a rising tide but by those positioned to navigate the currents with focus and conviction.
Footnotes
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Risk considerations
Investing involves risk, including possible loss of Principal. Past Performance does not guarantee future return. Potential investors should be aware of the risks inherent to owning and investing in real estate, including value fluctuations, capital market pricing volatility, liquidity risks, leverage, credit risk, occupancy risk and legal risk. Commercial real estate (CRE) investments carry several inherent risks, including those related to the economy, interest rates, and tenant behavior. These risks can impact property values, rental income, and overall investment returns.
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