Anna 
In a report released on Tuesday, the European Central Bank (ECB) indicated that the commercial real estate market in the euro zone may face prolonged challenges, posing potential risks to bank loan books, investment funds, and insurers.
A combination of economic weakness and elevated interest rates has led to a decline in real estate prices over the past year, impacting the profitability of real estate firms and challenging the overall business model of the commercial property market.
While the size of bank commercial real estate portfolios is not substantial enough to create a systemic risk for lenders, the ECB expressed concern that these portfolios could play a significant amplifying role in the event of broader market stress. The sector’s struggles could lead to shocks across the financial system, affecting a range of financial entities, including investment funds and insurance firms, collectively referred to as shadow banks.
The ECB noted in a Financial Stability Review article, “While the relatively limited size of bank commercial real estate portfolios implies that they are unlikely on their own to lead to a systemic crisis, they could play a significant amplifying role in the event of broader market stress.”
Residential mortgages account for approximately 30% of bank loan books, while commercial real estate makes up about 10%.
The report highlighted that commercial real estate transactions experienced a significant decline of 47% in the first half of 2023 compared to the same period in the previous year. This downturn in activity makes it challenging to accurately assess the extent of price drops. Notably, the euro zone’s largest listed landlords are trading at a discount of over 30% to net asset value, marking the largest such discount since 2008, according to the ECB.
The ECB pointed out that a sample of bank loans to real estate firms suggests that the recent increase in financing costs could potentially lead to the share of loans extended to loss-making firms doubling to as much as 26%. If tighter financing conditions persist as markets expect and firms are required to roll over all maturing loans over the next two years, this number could rise to 30%.
The report concluded, “There are substantial vulnerabilities in this loan book, particularly when considering that it is expected that both higher financing costs and reduced profitability will persist for a number of years. Business models established on the basis of pre-pandemic profitability and low-for-long interest rates may become unviable over the medium term.”
