Real estate: Danger signal for European real estate
Concerns are growing about the health of Europe’s commercial property market, with some investors wondering if it could be the next sector to collapse after last month’s banking crisis.
Higher interest rates have raised borrowing costs and squeezed valuations in the real estate sector, which in recent years has dominated amid low bond yields.
Meanwhile, the March collapse of US Silicon Valley Bank and the subsequent emergency bailout of Credit Suisse raised fears that a potential massive cash withdrawal from banks could spark a slump in the property sector.
The European Central Bank earlier this month warned of “clear signs of vulnerability” in the property sector, citing “reduced market liquidity and price corrections” as reasons for uncertainty and calling for new restrictions on commercial property funds to be eased the risks of a liquidity crisis.
Already in February, European funds investing directly in real estate recorded outflows of $215.4 million, according to data from Morningstar Direct – a sharp contrast to inflows of nearly $372 million in January.
Citi analysts now see European property stocks falling by 20%-40% between 2023 and 2024 due to higher interest rates. In a worst-case scenario, the higher-risk commercial real estate sector could collapse by 50% by next year, the bank said.
“Something I could not overlook is a crisis in real estate, both private and commercial, as we see a downward pressure both in the United States and in Europe,” Pierre Gramegna, managing director of the European Stability Mechanism, said in show by CNBC’s Joumanna Bercetche in Washington on Friday.
The office spaces
The office sector – a major component of the commercial real estate market – has emerged at the center of fears of a potential recession, given wider shifts to remote or hybrid working patterns following the coronavirus pandemic.
“People are concerned that the return to office hasn’t really materialized, so there’s too much vacancy [buildings] and too much lending in that sector as well,” Ben Emons, director and senior strategic adviser, said last month. portfolio manager at US-based investment management firm NewEdge Wealth on CNBC’s ‘Squawk Box Europe’.
That has heightened concerns about which banks might be exposed to such risks and whether a wave of forced sales could lead to a downward spiral.
According to Goldman Sachs, commercial real estate accounts for about 25% of the loan portfolio of US banks – a figure that rises to 65% among smaller banks, which have been at the center of recent pressures. In European banks, the corresponding percentage is around 9%.
“I think people are trying to figure out which banks have lent where, to what sector and what the ultimate risk here really is,” Emons added.
Amid this uncertainty and valuations it called too high, Capital Economics last month raised its forecast for a top-to-bottom correction in the eurozone property sector from 12% to 20%, with offices expected to suffer the worst impact.
“We see this financial distress, or whatever you want to call it, as a catalyst for a deeper adjustment in values than we previously expected,” Kiran Raichura, deputy chief real estate economist at Capital Economics, said in a recent webinar .
The image in Europe
In Europe, however, the situation is slightly better than in the US.
Pere Vinolas Serra, chief executive of Spanish real estate company Inmobiliaria Colonial and president of the European Public Real Estate Association, said the situation in Europe looks surprisingly strong.
Among the various factors at play in this divergence, he said, is that the trend back to offices has been stronger in Europe than in the US, while office “absorption” rates have been higher on the old continent.
“What’s impressive is that the data shows it’s better than ever,” Vinolas told CNBC via Zoom. “There’s something completely different going on in the US compared to Europe.”
At the end of 2022, the European office vacancy rate was around 7%, well below the 19% in the US, according to real estate consultant JLL. Within the Inmobiliaria Colonial portfolio, Vinolas said current vacancy rates were even lower, at 0.2% in Paris and 5% in Madrid.
“I have never seen this before in my life. Occupancy figures are at an all-time high,” Vinolas said.
JPMorgan appears to be embracing that view, saying late last month that fears of the US recession spreading to Europe were overblown.
“We believe that any contagion from either US banks or US CRE (commercial real estate) to Europe is not warranted, given the different dynamics of the sector,” the bank’s analysts said.
Uncertainties and opportunities
However, uncertainties remain.
Of particular concern is the pooling of funding from non-bank lenders – or so-called shadow banks – which have taken over the vacuum in the wake of tougher regulatory rules on traditional banks, said Matthew Pointon, senior real estate economist at Capital Economics.
Before the global financial crisis, Europe’s traditional banks offered loans of up to 80% of the value of a building. Today, the respective amounts rarely exceed 60%.
Meanwhile, EU and UK energy efficiency standards will require significant investment over the coming years, particularly in older buildings, putting further pressure on property owners. This is a development that is expected to create enormous pressures but also great opportunities.