Europe’s commercial property ‘not out of the danger zone’
• Nordic banks and German banks specialising in commercial real estate are seen to be pockets of weakness
UNLISTED GLOBAL
PROPERTY FUNDS
HAVE ... $811BN IN DRY
POWDER TO SUPPORT
CRE INVESTMENT
European banks appear better positioned than US peers to weather any stress from commercial property after an interest rate surge, but that does not mean Europe is out of the danger zone.
Aggressive rate hikes, still working their way through the system, follow a pandemic that hurt foot traffic to bricks-andmortar retail locations and changed work habits, with office occupancy rates still below preCovid-19 levels.
IMF estimates suggest banks’ direct exposure to commercial real estate (CRE) was about 6% of bank loans on average in Europe, versus about 18% in the US in 2022, meaning Europe appears less vulnerable to risks, analysts say.
Yet, with policymakers alert for what buckles under much higher borrowing costs, potential fault lines are being scrutinised.
Nordic banks and CREspecialist German banks could be pockets of weakness, especially if systemic risks emerge, Barclays said on Wednesday.
And though CRE risk was not front and centre of last week’s IMF meetings in Washington, concern was visible.
IMF MD Kristalina Georgieva stressed the need “to monitor risks that may be hiding in the shadows, in banks and nonbank financial institutions or in sectors such as CRE”. In its financial stability report, the IMF noted growing concerns about CRE given a heavy dependence on smaller banks. “Even in Europe then, there may be patches of propertyrelated vulnerability in the financial system, though none has yet emerged as a major threat to the banks,” said Capital Economics chief property economist, noting eurozone commercial property values were expected to decline about 20% before they bottom out.
The European Central Bank’s (ECB’s) main rate has jumped to 3% from -0.5% a year ago, and is headed higher.
A JPMorgan global investor survey cited CRE as the most likely cause of the next crisis.
“If you were to rank what are the biggest risks to your outlook, for us that (CRE exposure) would be among the top three,” said Robeco portfolio manager Daniel Ender.
In Europe, where offices account for the bulk of the real estate market, German and Nordic banks most exposed to construction and real estate activities were ones to watch.
Barclays said that if CRE became a larger systemic risk, Swedish banks could be more at risk. Borrowing by Swedish property companies has jumped to 2,300-billion Swedish krona ($223bn) in 2021 from 1,300billion krona in 2012.
German specialised property lenders such as Aareal Bank, Deutsche Pfandbriefbank and Berlin Hyp have a bigger concentration of real estate exposure, analysts said.
Robeco’s Ender said though big European banks did not have a “massive amount” of CRE exposure, equity market valuations signalled pain for real estate companies, with German names trading at substantial discounts to their assets as valued by third-party appraisals.
REFINANCING
Tighter bank financing conditions reinforce the effects of higher interest rates, making refinancing tougher over the coming years, analysts said.
The ECB’s banking supervisor in 2023 found “deficiencies” at most banks in how they assess prospective borrowers’ ability to repay. CRE accounts for as much as 30% of nonperforming loans across European banks, it said.
Possible redemptions from real estate investment funds, making up 40% of the eurozone CRE market in 2022, having doubled over a decade, according to the ECB, was another worry. It has warned that “forced liquidation of real estate assets to meet investor redemptions might lead to downward pressure on CRE prices”.
Blackstone recently blocked withdrawals from its $70bn real estate income trust after facing a flurry of redemption requests. Open-ended real estate funds in Britain have also battled to meet strong demand for redemptions.
“It’s a little bit circular: if banks are finding stresses in other parts of their balance sheets and need to focus on preserving capital to reserve against those losses, this might impact their ability to refinance existing CRE loans, triggering a selffulfilling prophecy,” said Hans Vrensen, head of research and strategy at real estate investment firm AEW.
In Europe, CRE exposure for smaller banks, more at risk of deposit flight, is estimated at less than 30% of all loans, Capital Economics said. Tighter bank regulation also suggests European banks have less to fear.
“Banks are in a much better position this time round with larger reserves against potential losses; if you look at the tier one capital ratios, especially in countries like Italy and Spain,” said Massimo Bianchi, head of special situations real estate at illimity Bank.
Unlisted global property funds meanwhile have as much as $811bn in dry powder to support CRE investment when markets recover, Savills estimates. About $500bn of this war chest is focused on European assets.
Even if the sector can weather the pain of higher rates, climate risks pose challenges.
“On one side, there is pressure on lenders to lend more to green projects,” said Jackie Bowie, managing partner at Chatham Financial. “On the other, real estate owners themselves are going to face increase in costs.”