Crisis radar falls on fault lines in Europe's commercial property
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[April 20, 2023] By
Chiara Elisei and Dhara Ranasinghe
LONDON (Reuters) - European banks appear better positioned than U.S.
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,
follows a pandemic that hurt foot traffic to bricks-and-mortar retail
locations and structurally changed work habits, with office occupancy
rates still below pre-COVID levels.
International Monetary Fund estimates suggest banks' direct exposure to
commercial real estate (CRE) was around 6% of bank loans on average in
Europe, versus about 18% in the United States last year, 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 CRE-specialist German banks could be pockets of
weakness, especially if systemic risks emerge, Barclays said on
Wednesday.
And although CRE risk was not front and centre of last week's IMF
meetings in Washington, concern was visible.
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IMF Managing Director Kristalina Georgieva stressed the need "to monitor
risks that may be hiding in the shadows, in banks and non-bank 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 property-
related vulnerability in the financial system, though none has yet
emerged as a major threat to the banks," said Capital Economics chief
property economist Andrew Burrell, noting euro zone commercial property
values were expected to fall about 20% before they bottom out.
The European Central Bank's key rate has jumped to 3% from -0.5% a year
ago, and is headed higher.
A recent JP Morgan 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.
FAULT LINES
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 seen as 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 crowns ($223 billion) in 2021 from 1,300
billion crowns in 2012.
German specialised property lenders such as Aareal Bank, Deutsche
Pfandbriefbank and Berlin Hyp, have a bigger concentration of real
estate exposure, analysts added.
Aareal Bank declined to comment. Deutsche Pfandbriefbank and Berlin Hyp
did not return a request for comment.
Robeco's Ender said although big European banks did not have a "massive
amount" of CRE exposure, equity market valuations signalled significant
pain for real estate companies, with German names especially trading at
substantial discounts to their assets as valued by third-party
appraisals.
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Lights are seen in windows of an office
building early in the morning in Brussels, Belgium, October 28,
2022. REUTERS/Yves Herman/File Photo
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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 last year found "deficiencies" at most
banks in how they assess prospective borrowers’ ability to repay.
CRE accounts for as much as 30% of non-performing loans across
European banks, it said.
Possible redemptions from real estate investment funds, making up
40% of the euro zone 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 $70 billion 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
self-fulfilling 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 under 30% of all loans, Capital Economics
said. Tighter bank regulation also suggests European banks have less
to fear.
"[European] 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, it
has stepped up tremendously," said Massimo Bianchi, head of special
situations real estate at illimity Bank.
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Unlisted global property funds meanwhile have as much as $811
billion in dry powder to support CRE investment when markets
recover, Savills estimates. Around $500 billion of this war chest is
focused on European assets.
Even if the sector can weather the pain of higher rates, climate
risks pose longer-term 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 quite
material increase in costs."
($1 = 10.3323 Swedish crowns)
($1 = 0.9147 euros)
(Reporting by Chiara Elisei and Dhara Ranasinghe; Additional
reporting by Yoruk Bahceli in Amsterdam, Sinead Cruise in London and
Francesco Canepa in Frankfurt; Editing by Sharon Singleton)
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