Fears mount European commercial real estate could be the next to blow
Investors are questioning the health of the commercial real estate sector following a string of recent banking crises.
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Concerns are mounting around the health of Europe’s commercial real estate market, with some investors questioning whether it could be the next sector to blow following last month’s banking crisis.
Higher interest rates have increased the cost of borrowing and depressed valuations in the property sector, which in recent years reigned supreme amid low bond yields.
Meanwhile, the collapse in March of U.S.-based Silicon Valley Bank and the later emergency rescue of Credit Suisse prompted fears of a so-called “doom loop,” in which a potential bank run could trigger a property sector downturn.
The European Central Bank earlier this month warned of “clear signs of vulnerability” in the property sector, citing “declining market liquidity and price corrections” as reasons for the uncertainty, and calling for new curbs on commercial property funds to reduce the risks of an illiquidity crisis.
Already in February, European funds invested directly in real estate recorded outflows of £172 million ($215.4 million), according to Morningstar Direct data — a sharp contrast from the inflows of almost £300 million seen in January.
Analysts at Citi now see European real estate stocks falling by 20%-40% between 2023 and 2024 as the impact of higher interest plays out. In a worst-case scenario, the higher-risk commercial real estate sector could plummet 50% by next year, the bank said.
A reckoning for office space
The office segment — a major component of the commercial real estate market — has emerged as central to potential downturn fears given wider shifts toward remote or hybrid working patterns following the Covid pandemic.
“People are concerned that the back-to-office hasn’t really materialized, such that there are too many vacancies and yet there is too much lending in that area, too,” Ben Emons, principal and senior portfolio strategist at U.S.-based investment manager NewEdge Wealth, told CNBC’s “Squawk Box Europe” last month.
People are trying to understand which banks have lent where, to what sector, and what’s really the ultimate risk.
Ben Emons
principal and senior portfolio strategist at NewEdge Wealth
That has deepened worries about which banks may be exposed to such risks, and whether a wave of forced sales could lead to a downward spiral.
According to Goldman Sachs, commercial real estate accounts for around 25% of U.S. banks’ loan books — a figure that rises to as much as 65% among smaller banks, the focus of recent stressors. That compares to around 9% among European banks.
“I think people are trying to understand which banks have lent where, to what sector, and what’s really the ultimate risk here,” Emons added.
Amid that uncertainty, and what it called stretched valuations, Capital Economics last month increased its forecast for a peak-to-trough euro zone property sector correction from 12% to…
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