Experts Warn of Potential Crisis in Europe’s Commercial Real Estate Market

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Europe’s commercial real estate market has emerged as the next potential sector to take a hit following the banking crisis that hit last month. Concerns are mounting over the sector’s health as higher interest rates increased the cost of borrowing and decreased valuations in the property market, which had been performing well due to low bond yields. The European Central Bank has also expressed concerns over declining market liquidity and price corrections and has called for new limits on commercial property funds to lower the risks of an illiquidity crisis. 

A Potential Crisis in Real Estate 

Experts fear real estate, particularly the higher-risk commercial sector, could plummet 50 percent by next year. Analysts at Citi predict that European real estate stocks could fall by 20 to 40 percent in the 2023 to 2024 period as the impact of higher interest rates plays out. Experts have also expressed concerns about the risks to both private individuals and the commercial real estate sector in the US and Europe. 

The office segment, a significant commercial real estate market component, has emerged as central to potential downturn fears. Wider shifts towards remote or hybrid working patterns following the COVID-19 pandemic have increased worries about which banks may be exposed to the risks and if forced sales could end up in a downward spiral. Commercial real estate accounts for around 25 percent of US banks’ loan books but as much as 65 percent among smaller banks, the focus of recent stressors. This compares with around nine percent among European banks. 

Mixed Views on the Risks

Some experts have a different perspective, stressing that the situation in Europe looks paradoxically strong, and the return-to-office trend has been higher in Europe than in the US. 

Office occupancy rates have also been higher on the continent. As of late 2022, European office vacancy rates were seven percent, well below the 19 percent in the US. JPMorgan also shares this view, stating that they do not believe any contagion from US banks or commercial real estate onto European peers is justified, given different sector dynamics. 

The concentration of funding from nonbank lenders is of particular concern in the commercial real estate sector. Shadow banks have picked up the slack due to tighter regulations on traditional banks. Before the global financial crisis, traditional European banks would offer loans of 80 percent of a building’s value. Today, they rarely go above 60 percent, raising concerns about the unknown risk shadow banks pose. 

The incoming EU and UK energy efficiency standards will require significant investment, particularly in older buildings. This could see some real estate owners under further pressure over the coming years, particularly those with a building that must adapt to new requirements. The challenge will be for those less sophisticated players, and there could be a huge impact and significant opportunities. 

To Wrap Up

Europe’s commercial real estate sector is facing significant uncertainties, with fears mounting that it could be the next sector to fall following the banking crisis last month. While some analysts believe that the risks are less acute in Europe than in the US, concerns remain over the concentration of funding from nonbank lenders, the impact of incoming energy efficiency standards, and the potential unknown risks posed by shadow banks.

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