- Concerns about the current state of the European commercial real estate market are on the rise.
- Investors fear that this is the next sector to implode after the recent banking crisis.
- If the so-called fatal loop occurs, a possible bank run would send the real estate sector into recession.
The health of Europe’s commercial real estate market is a concern for some investors, who fear that this sector could be the next to implode after the banking crisis in March.
Following aggressive interest rate hikes by the European Central Bank, the cost of borrowing rose substantially. This contributed to depressing sector valuations that were at very high levels for years while bond yields were low.
Fears of a doomsday loop are based on the recent collapse of Silicon Valley Bank and the closure of Signature Bank in the United States, along with the emergency bailout of Credit Suisse. If so, a potential bank run could trigger a recession in the sector.
“Clear signs of vulnerability”
In early April, the ECB warned that there are “clear signs of vulnerability” in the European real estate sector. Its projections are based on “declining market liquidity and price corrections.”
The European issuer said that further restrictions on commercial property funds were necessary in order to reduce the risks of a liquidity shortage crisis.
European funds that had made direct investments in real estate recorded outflows of £172 million ($215.4 million) in February, according to data from Morningstar Direct. This compares with inflows of almost £300 million in January.
For Citi analysts, European real estate stocks could fall between 20% and 40% this year and next, as a result of the impact of rising interest rates. It is even estimated that the fall in the riskiest commercial real estate sector could be 50% by 2024, the bank said.
“One thing I would not overlook is a downturn in real estate, both for individuals and commercial real estate, where we see downward pressure in both the U.S. and Europe,” European Stability Mechanism managing director Pierre Gramegna said this week, as quoted by CNBC.
Fears about office space
As for the office segment, which is considered one of the most important areas of the real estate market, fears are not minor. A possible recession is not ruled out due to the change in remote or hybrid work patterns after the Covid 19 pandemic.
“People are concerned that back-to-office hasn’t really materialized, so there are too many vacancies, and yet there are also too many loans in that area,” argued Ben Emons, principal and senior strategist at investment manager NewEdge Wealth.
To try to look for clear clues as to what might happen, people look for information related to which banks have lent money, where they have directed their lending and which sector has been favored, Emons said.
This has only deepened concerns about banks that could be exposed to greater risk if there is a wave of nervous or forced selling leading to a downward spiral.
According to Goldman Sachs data, commercial real estate accounts for about 25% of U.S. banks’ loan books. Among smaller banks, which have been hardest hit by high interest rates, this figure rises to 65 %. Among European banks, on the other hand, the percentage is about 9%.
In March Capital Economics increased its forecast for a correction in the eurozone real estate sector from peak to trough of 12% to 20%. At these stretched valuations as the firm calls them, offices are expected to fare worse.
“We see this financial distress, or whatever you want to call it, as a catalyst for a deeper value adjustment than we previously expected,” said Capital Economics deputy chief property economist Kiran Raichura.
Risks in Europe are lower than in the U.S.
Not all analysts agree that there will necessarily be a recession, though. At least that is the view of the CEO of Spanish real estate company Inmobiliaria Colonial, Pere Viñolas Serra.
According to the also president of the European Association of Public Real Estate, in Europe the situation seems to be paradoxically strong.
The risk indicators for this to happen are the trend of return to the office, which in Europe is greater than in the U.S., the executive commented. While office “recovery” or occupancy rates in Europe have also been higher.
“The amazing thing is that the data shows it’s better than ever,” Vinolas noted. He added that “something totally different is happening in the U.S. versus Europe.”
Office availability rates on the European continent at the end of last year were 7%. This is substantially lower than the 19% in the U.S., says real estate advisor JLL. While in the case of Inmobiliaria Colonial, vacancy rates are currently lower, at 0.2% in Paris and 5% in Madrid.
“I’ve never seen that in my life. The data on occupancy rates are at the highest level,” Vinolas said.
For its part, JPMorgan also believes that fears of a U.S. recession spreading to Europe are overblown.
“Fundamentally, we believe any contagion from U.S. banks or U.S. CRE (commercial real estate) to their European peers is unwarranted, given the different sector dynamics,” the bank’s analysts said.
Uncertainty remains
That’s not to say that uncertainty about the sector’s performance this and next year doesn’t exist, analysts said. One of the biggest concerns is the way financing from non-bank lenders has been concentrating.
So-called shadow banks have come into play following the imposition of tighter regulations on traditional banks, said Capital Economics senior property economist Matthew Pointon,
Before the 2008 global financial crisis, for example, traditional European banks offered loans of up to 80% of a property’s value. Today such loans are hardly ever more than 60%.
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