Now well into the second half of 2025, one lesson remains clear: in commercial real estate, change is the only constant. The past few years have fundamentally reshaped how we underwrite, deploy capital, and manage risk. Today’s market is defined by economic uncertainty, evolving space utilization trends, and capital markets still recalibrating from a cycle of inflation and aggressive policy tightening.
Against this backdrop, Cottonwood interprets the macro environment, identifying opportunities, and shaping strategy. From credit markets to sector-specific trends and geographic themes, our focus remains on downside protection, cash flow visibility, and precision underwriting—not generalization.
Economic Trends and Policy Impacts on Real Estate
Our base case for the remainder of 2025 is characterized by slow real growth combined with persistent inflation. GDP is tracking below 1.5% for the year, with industrial production and retail sales decelerating. Meanwhile, core inflation remains sticky at 2.8% year-over-year, and headline CPI is approaching 3.0%, with further upward pressure likely as the full effect of the April 2025 tariff package takes hold.
Labor market signals are flashing caution. Monthly payroll growth has slowed to an average of 124,000 jobs in 2025, compared to 168,000 last year. The concentration risk is even greater since over 60% of May’s job creation was in education and healthcare. The economic foundation is more vulnerable when the job market is less diversified.
The Federal Reserve appears to be navigating a delicate policy balance. While markets are pricing in 50 basis points of cuts this year, our expectation is for one 25bp cut in Q4, with more meaningful easing in 2026. Terminal rates will likely settle between 2.75% and 3.00%. In this context, borrowing costs remain range bound. Short-duration financing is still optimal, and while spreads have tightened from mid-2024 levels, they remain elevated compared to pre-2022 norms.
Credit Markets Signal a Gradual Recovery
It is encouraging to see signs of liquidity returning to real estate credit markets. Non-agency CMBS issuance is up 31% year-over-year through May, and BBB- spreads have tightened by 90 basis points, reflecting improved sentiment. Debt funds are also reengaging, although leverage levels remain conservative, typically capped at 55–60% LTV.
Sponsors are leaning into structure. There’s increased reliance on preferred equity, mezzanine capital, and A/B note strategies to manage capital stack complexity and optimize cost of capital. Our focus has been on originating senior bridge loans for transitional assets and mezzanine positions in capital-starved projects where we can achieve strong basis protection.
In all cases, Cottonwood prioritizes cash flow durability, protective covenants, and asset-level downside protection. Structured credit, when used effectively, serves as both a protective measure and a strategic tool.
Sector Outlook: Growth for Some, Disruption for Others
The story across property sectors is one of bifurcation between haves and have-nots, between durable demand drivers and outdated formats.
Office
In the office sector, national vacancy stands at 17.6%, with major urban cores like San Francisco and Chicago seeing rates well over 20%. However, suburban office leasing is quietly up 6% year-over-year in metros like Raleigh and Tampa, and smaller floor plates and flexible footprints are gaining traction. We see value in shorter-duration debt on suburban repositionings as well as bridge loans supporting well-located office-to-residential conversions, a trend that has been growing significantly, with over 15 million square feet converted since 2023.
Industrial
Industrial fundamentals remain strong. National vacancy is just 4.2%, and rent growth continues at a healthy 9% year-over-year pace. Over 60% of large leases are built-to-suit, signaling tenant commitment in core markets. Demand tailwinds from AI infrastructure and post-pandemic supply chain reconfiguration remain durable. We are particularly focused on sale-leasebacks and assets with credit tenants in mid- and last-mile hubs.
Retail
Retail continues its quiet reinvention. National vacancy is a manageable 5.3%, and leasing activity is up 7% year-over-year. Experiential retail is no longer a niche where approximately 35% of new leases include food, beverage, and entertainment components. We are pursuing open-air centers in high-growth metros and strip centers anchored by medical or essential services.
Multifamily
Multifamily has held up well, with national rents up 4.7% and even higher in Sun Belt markets like Phoenix, Tampa, and Charlotte. Despite this, there are cracks developing. Over 500,000 units are currently under construction, with roughly 20% facing delays due to financing or permitting issues. Our approach is disciplined, looking for stabilized deals with repositioning potential, while avoiding overleveraged merchant build projects, especially in oversupplied submarkets.
Hospitality
Hospitality continues its post-COVID rebound. RevPAR is up 6.4% year-over-year, led by leisure-heavy markets such as Miami and Charleston. Urban business travel is recovering, though still trailing pre-COVID levels by about 10%. We are finding value in repositioning dated assets into lifestyle or soft-branded offerings and in select-service hotel acquisitions trading below replacement cost.
Market Selection Guided by Fundamentals
Geographic selectivity is a central pillar of our strategy. We remain bullish on growth markets like Austin, Raleigh, and Phoenix, where tech migration, population growth, and industrial activity provide solid fundamentals. Nashville stands out for its scalable office-to-residential conversion activity.
Sun Belt metros continue to benefit from business-friendly environments and demographic momentum. Meanwhile, Midwest markets such as Columbus and Indianapolis offer compelling risk-adjusted yields without the volatility of gateway cities.
Positioning in a Volatile REIT Environment
Public REITs are showing signs of stabilization. The FTSE NAREIT All Equity REIT Index is up roughly 7% year-to-date, recovering from a multi-year trough. Yet dispersion remains. Industrial and data center REITs command premiums to NAV, while office REITs continue to trade at deep discounts. REITs, particularly those with strong balance sheets, are regaining access to unsecured debt markets. However, smaller names remain capital constrained.
Apart from REITs, Real Estate Operating Companies offer differentiated exposure, often encompassing development-oriented platforms, infrastructure plays, and master-planned communities. There are a number of Real Estate Operating Companies that trade below NAV, offering value to long-term investors who are willing to accept volatility.
We are also watching real estate services companies closely. Their asset-light business models and operating leverage benefit directly from the recovery in transaction volumes and advisory mandates. These platforms are cyclical, but they provide a lens into market sentiment and forward deal flow.
Deploying Capital with Precision and Protection
We are positioning our portfolio as follows: 70% to credit opportunities, 20% to structured equity and preferred instruments, and 10% to opportunistic equity. Our highest conviction lies in multifamily assets in infill locations, value-add retail with experiential overlays, and industrial facilities near Tier 2 metros with supportive infrastructure investment.
Conversely, we are steering clear of high-vacancy urban offices without a clear conversion plan, ground-up multifamily in oversupplied zones, and long-duration fixed assets lacking visibility on exit or refinance.
Finding Value Others Miss
We do not believe this is a moment for broad brush investing. Instead, we are focused on curated transactions that offer both downside protection and upside optionality. The best deals of 2025 are characterized by motivated sellers, capital stack distress, top-tier location, and mispricing driven by dislocation rather than fundamentals. Institutional-quality real estate that’s temporarily out of favor is where patient capital can shine.
With granularity and conviction, we underwrite with asymmetry, seeking structures that cap our downside while allowing us to participate on the upside. It is this mindset that guides our mezzanine and preferred equity strategies as well as how we approach every new opportunity.
Today’s real estate environment favors those who bring focus, creativity, and precision to their approach. While challenges persist, meaningful upside remains for those who understand where to find it and how to structure transactions effectively. In this market, timing and disciplined selectivity are paramount.