A new report from the International Monetary Fund is warning that the downside risk for commercial real estate remains high as the cost of debt continues to affect property values and future rate cuts remain vulnerable to inflation and geopolitical tension.
The 16 April Global Financial Stability report sets out its assessment of key risks to the global economy, with the Washington, DC-based agency cautioning against complacency over interest rate decreases. As inflation remains above target, central banks might not deliver the cuts the financial market is expecting, putting real estate borrowers under continued strain in the coming months, the report stated.
On the strength of better-than-expected inflation data and positive remarks from the US Federal Reserve in January, bank lending rates started to decline across the globe. However, at the time, real estate experts still cautioned Real Estate Capital Europe inflationary pressures might mean high debt costs would not necessarily be transitory.
The IMF reported the all-in cost of debt for UK commercial real estate borrowers was between 7 and 8 percent in the third quarter of 2023 – above the prime all-sector commercial UK yield of around 6 percent. Costs of borrowing in continental Europe during the same period were around 5 percent – on par with the prime yield on the continent. However, it added further property price declines could materialise and lead to “painful economic losses”.
The agency predicted Europe’s real estate values could drop by 20 percent overall, and by 25 percent in the office sector over the next three years – in a “severely adverse scenario”.
It explained: “The last mile of disinflation… may be complicated by several near-term, salient financial fragilities. Stress in the commercial real estate sector has become more acute, with more borrowers likely in trouble, and with a number of banks around the world being scrutinised by investors over commercial real estate-related loan losses.”
The IMF said while banks “appeared well positioned” to absorb property losses in aggregate, certain economies “may experience more strains” given their banks hold large amounts of commercial real estate loans.
“Most banks appear to have adequate loan-loss reserves and capital buffers to absorb potential commercial real estate losses, but some have come under investor pressure recently. For example, the stock prices of a number of banks around the world declined precipitously after they announced losses or provisions on their US commercial real estate portfolios,” it added.
Munich area-headquartered pbb Deutsche Pfandbriefbank saw its share price fall during March after it revealed it had set aside €212 million in loan loss provisions to cover potential defaults on commercial property loans in 2023 – from €44 million in the previous year.
Rating agency DBRS Morningstar said on 17 April German banks’ US office property loans were driving material increases in non-performing loans and loan loss provisions.
It said: “Actual credit losses could remain contained as long as distressed sales can be avoided. However, the longer and broader the market downturn, asset sales become a more likely option to offset increasing NPLs in banks’ portfolios.”
