From Reset to Recovery: The Drivers of Commercial Real Estate Returns

By Laus Abdo, Founder & CEO, AGP Capital &

Maya Saraf, Associate, AGP Capital

Current Cycle Position

As a commercial real estate lender, a common question we receive is “where are we in the cycle?” Given the evolving political and economic backdrop, the answer remains nuanced. While the market is showing signs of recovery, outcomes continue to be shaped by broader forces such as geopolitical pressures and shifting trade policy. 

One of the indicators we closely monitor is transaction activity. When the Federal Reserve (“Fed”) began raising interest rates in March 2022, commercial real estate activity slowed. The rising cost of capital reduced transactions and widened the price gap between buyer and seller expectations. Asset values began to correct, most notably in the office sector, which faced the combined pressures of elevated interest rates, persistent remote work, and widespread corporate downsizing, particularly within the technology industry. Following a period of banking stress and the failures of Signature Bank, Silicon Valley Bank, and First Republic Bank in early 2023, traditional bank lenders, specifically community and regional banks (that are primary lenders to local real estate developers and investors), retreated from the sector, further constraining transaction volume. 

After remaining subdued through 2023 and much of 2024, transaction activity began to recover following the Fed’s rate cuts in late 2024. While trade policy loomed large in Q1 2025, transactions rebounded in Q2 and Q3 and continue to trend upward into Q4, supported by additional rate cuts in Fall of 2025 and generally downward trending interest rates. As asset values reset, investors have been capitalizing on opportunities to acquire properties at pricing supported by current market fundamentals. 

September 2025 was the strongest month of the year so far, posting ± $27Bn in transaction activity. The office sector is stabilizing, with positive leasing momentum for newer and significantly upgraded buildings in high-demand locations. Retail remains resilient, buoyed by limited new supply and strong tenant demand. Multifamily performance has improved as excess inventory is gradually absorbed and new development pipelines moderate. Meanwhile, the industrial sector is stabilizing as recent deliveries are leased up. Taken together, these trends signal a cautiously improving market that continues to find its footing amid a shifting macroeconomic backdrop. Looking ahead, commercial real estate returns are expected to align with long-term historical norms, with income playing a larger role than appreciation. Operators who drive steady leasing and manage operations efficiently are best positioned to deliver durable returns. 

Capitalization Rates and Commercial Real Estate Returns 

A capitalization rate (“cap rate”) is the ratio of a property’s net operating income (i.e., income remaining after operating expenses) to its market value. The cap rate reflects the portion of total return expected from the property’s current income. Cap rates typically range from 1% to 2% or higher than the yield on the 10 Year Treasury. This spread compensates investors for the illiquidity, tenant quality, lease duration, and ongoing operating expenses associated with commercial real estate investments.  

When interest rates are near zero, as experienced during March 2020 to March 2022, borrowing costs decline and capital flows aggressively into commercial real estate. Investors are driven by both inexpensive financing and the search for higher yield relative to low-return fixed-income alternatives. Increased competition for a limited supply of assets pushes prices higher and cap rates lower, resulting in rising valuations. In these environments, a larger share of total returns is driven by appreciation. 

Conversely, in rising interest rate environments, such as the period from March 2022 through December 2024, borrowing costs increase and investors require higher returns to justify holding real estate relative to traditional fixed-income assets that now offer more attractive yields. Higher debt costs reduce the prices buyers can support, pushing cap rates higher and values lower. Even when properties generate steady income, higher cap rates reduce the valuation of that cash flow. As valuations soften, income accounts for a greater share of total return, placing increased importance on durable income supported by long-term leases, strong tenants, inflation-linked rent escalations and renewals, and efficient operations. 

Past versus Future Expected Returns 

Historically, commercial real estate has delivered average annual returns of approximately 8% to 10%, with roughly two-thirds derived from income and one-third from appreciation. Looking ahead, income is expected to represent a larger share of total returns as higher borrowing costs and slower rent growth constrain capital appreciation. As a result, investors are increasingly prioritizing income durability over aggressive yield chasing, with a focus on core-plus and value-added strategies and sector diversification. Income-oriented commercial real estate can serve as a complement to traditional fixed income, offering higher yields and inflation protection through rent escalations. Well-managed assets with stable occupancy and appropriately structured leverage can generate returns comparable with public equities at a lower volatility. Vehicles such as core open-end funds and non-traded income REITs, which emphasize consistent income over appreciation, are well aligned with current market conditions. 

Final Thoughts

Commercial real estate is moving from a period of reset toward gradual recovery, supported by improving transaction activity and downward trending interest rate expectations. In this environment, income is expected to drive a larger share of total returns as appreciation moderates. Durable, well-managed cash flow backed by strong tenants, long-term leases, and efficient operations will be essential to performance. Investors who focus on resilient income and disciplined leverage are well positioned for this stage of the cycle, with income-oriented investment vehicles aligning especially well with current market conditions.