Commercial real estate prices in Europe are falling

Raised interest rates in the Eurozone and lower profitability of the commercial real estate sector in the coming years could call into question the recovery of loans and expose banks to risk, the European Central Bank (ECB) found.

Commercial real estate prices in Europe are falling due to a weak economy and high interest rates and are challenging the sector's profitability and business model, the ECB concluded in a financial stability report published on Tuesday.

The sector does not represent a systemic risk for lenders because it is not large enough, but it could intensify shocks in the financial system and significantly affect a wide range of financial companies, from investment funds to insurance companies, they warn.

"Portfolios of commercial real estate in bank assets are relatively limited, which means that they will probably not lead to a systemic crisis by themselves, but in case of stress on the wider market, they could play the role of a significant 'amplifier'", they warn.

Banks have decided to reduce exposure to the struggling Austrian real estate giant Signa Group after talks with supervisors at the ECB, sources told Reuters at the beginning of the month.

In the middle of the year, Signa Group owed banks in Austria about 2.2 billion euros, according to informed sources, and two thirds of the amount were loans from Raiffeisen Bank International (RBI) and UniCredit's Bank Austria.

The German construction company Lupp suspended the construction of a skyscraper in Hamburg at the beginning of the month because Signa, the investor, was late with payments.

The ECB said in the report that residential mortgage loans account for about 30 percent of bank loans and commercial real estate loans for about 10 percent.

In the first half of the year, the number of transactions with commercial real estate was almost halved compared to the same period last year, which makes it difficult to assess price movements, the central monetary institution of the eurozone notes.

It is difficult to say how much the prices have fallen, but the movement of real estate company stock prices on the stock exchanges leads to the conclusion that the fall is significant, they point out, adding that the share price of the largest landlords in the Eurozone is lower by up to 30 percent of the net asset value per share.

The pattern of bank loans to real estate companies implies that raising financing costs could double the share of loans to loss-making companies to as much as 26 percent, the ECB calculated.

From July last year to mid-September, the ECB raised interest rates in the eurozone by as much as 4.5 percentage points in order to curb inflation by limiting consumption.

If interest rates remain at their current level for the next two years and if companies are forced to reschedule all loans due, the share of such loans will rise to 30 percent, the ECB calculated.

"That loan portfolio contains significant weak points, especially when it is taken into account that financing costs will remain at a higher level and profitability will be weaker for a number of years", they add.

"The business model established on the basis of pre-pandemic profitability and low interest rates over a long period of time could become unsustainable in the medium term," says the ECB, reports poslovni.hr.

Tržište nekretnine, 22. Nov. 2023.