Not only the US commercial real estate market is struggling with historically low prices due to interest rate hikes and the trend of working from home. Europe, too, is in trouble. Financial institutions with large exposure to this sector are being hit hard, while interest rate cuts are failing to materialise.
Turmoil over the potential pain for financiers of commercial real estate in the United States soared last week after New York Community Bancorp announced it was raising its provisions for possible credit losses on commercial real estate loans in the United States. The market sent the stock down 40 percent. On Monday, shares fell further: -10 percent.
It is expected that other US banks may have to take similar measures, judging by the 10 per cent drop in the KBW Nasdaq Regional Banking Index since last week. Indeed, smaller and regional banks - which fall outside the top 25 banks based on domestic assets - are more sensitive to price declines in commercial real estate than Wall Street. The exposure is 4.8 times greater.
The combination of high interest rates and reduced demand for office space makes it harder for developers to finance their debt. The solution - lower interest rates - was again delayed by the Federal Reserve and the European Central Bank in January, to the frustration of investors.
Barry Stuart Sternlicht, CEO of Starwood Capital Group, argues that the US office market is in an existential crisis. “We are looking at an asset class that was once worth 3,000 billion dollars, but is now probably worth only 1,800 billion dollars. There is 1,200 billion in lost value, and it is unclear exactly where those losses are,” Sternlicht said at the Global Alts Conference in Miami last week.
However, Sternlicht also sees a positive side: the situation in the office market seems to be a typical American phenomenon. “In Munich, rents are up 15 per cent and the vacancy rate is only 2 per cent. In Seoul, Korea, it is 1 per cent and in Tokyo 4 per cent,” he added.
Europe
Despite an estimated 6.9 percent average vacancy rate for European offices, IMF researchers, including financial sector expert Andrea Deghi, argue that the risks of the commercial real estate sector are indeed relevant to Europe, where the IMF says the same factors are at play as in the US.
Europe’s commercial real estate sector is entering a period of rising defaults caused by rapidly falling property prices, substantial maturing debt and tighter lending standards from bank lenders, Deghi said in the IMF’s latest Global Financial Stability Report. ‘Corporate and business cash reserves are beginning to erode as interest coverage ratios fall and profits are expected to decline.’
In Europe, where debt related to commercial real estate is 12 percent of GDP (18 percent in the US), banks report a rise in bad loans, especially loans of old or poorly located office properties, the IMF said. In the first quarter of 2023, commercial real estate loans accounted for about 30 percent of all non-performing loans in Europe.
This was confirmed in practice last week when Julius Bär, the Swiss asset manager, reported a net credit loss of $701 million due to exposure to Austrian real estate group Signa Holding, owner of the Chrysler Building in New York, among others. Julius Bär said it was writing off this exposure, but the final losses exceeded market expectations. CEO Philipp Rickenbacher announced his departure and announced 250 job cuts.
Problems with refinancing property loans in Europe hit not only Signa, but also German property developer Aroundtown and Swedish companies Castellum, SBB and Pandox. Deutsche Bank AG also had to quadruple its provisions for property losses. This case involved exposure to US real estate.
ECB already noted slide in 2023
The European Central Bank reported that trading in European commercial real estate fell by as much as 47 percent in the first half of 2023 compared to the same period last year. Analysis shows that the recent surge in borrowing costs could potentially double the share of loss-making companies in the loan book to 26 percent.
Like the IMF, the central bank points to “significant vulnerabilities” within these portfolios, partly because of persistently higher funding costs and declining profitability. These are problems that are expected to “persist for years to come,” the ECB said.
The exact decline in property prices is still unknown. ECB data show that the largest listed property landlords are currently trading at a discount of more than 30 per cent to net asset value. This is the biggest discount since the 2008 financial crisis, and marks a low since the start of the pandemic.
According to Peter Papadakos, head of European research at Green Street, an independent real estate research firm, for every euro borrowed in 2020, office building owners may now be able to recoup only 75 cents, due to weak office market fundamentals and limited rental growth.
Deep discounts
Meanwhile, some US financiers see their opportunity to buy up the battered properties at deep discounts. For instance, RXR, a leading property developer in New York, announced in January that it is launching a one billion dollar fund in partnership with private equity firm Ares Management. This fund will focus on investing in distressed office buildings in the city.
The partners are optimistic and believe the stagnation in the office market, caused by uncertainty over interest rates and the impact of working from home, is fading. They expect that many parties will be willing to take losses on the sale or restructuring of their properties.
“We now have clarity on interest rates, clarity on the future of office space and an understanding of which buildings will be competitive. A capitulation is taking place, a recognition that values will not simply recover as they did in 2008,” RXR ceo Scott Rechler told the FT.
Furthermore, Manhattan-based private equity firm Northwind Group has already made some $300 million in commercial real estate loans in the first month of 2024, doubling from January last year, reports MarketWatch. Northwind Group plans to lend between $1.5 billion and $2 billion this year.
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