Real estate companies are hit by losses

Eurozone property companies are suffering from mounting losses and some will struggle to service their debts, which have risen to a higher level than before the 2008 financial crisis, the European Central Bank has warned.

The losses, which the ECB said would have "consequences for the resilience of banks' loan portfolios", stem from significantly higher funding costs, falling commercial property values, lower rental income and growing concerns about the energy efficiency of of buildings.

It is noted that tighter financing conditions have reduced affordability and demand for real estate assets, putting downward pressure on prices.

They also increased the debt servicing costs faced by existing borrowers, with the most over-indebted borrowers in countries with widespread floating-rate lending most affected.

According to the Financial Times, the strong labor market has so far supported household balance sheets, reducing credit risk on banks' relatively large residential exposures.

Commercial real estate companies, in contrast, have faced more serious challenges in a context of rising financing costs and declining profitability. While banks have smaller exposures to commercial real estate markets, losses in this segment could act as a buffer in the event of a broader shock.

The central bank said signs of stress in the commercial real estate sector, which accounts for 10% of all eurozone bank lending, "have the potential to significantly amplify an adverse scenario" and "will lead to large losses" in the wider financial system.

The average debt of Europe's biggest real estate firms has risen to more than 10 times their earnings, "close to or above pre-global financial crisis levels," the ECB said in its financial stability review .

It is noted that the ECB interest rate hikes hit the industry hard. It now costs 2.6 percentage points more to finance the commercial real estate market in Europe than before interest rates started rising last year, according to data from the eurozone credit registry.

The central bank's benchmark deposit rate is now 4% – up from -0.5% per cent before the tightening cycle began.

Rising borrowing costs will pose a refinancing challenge for the most indebted companies, the ECB said, noting that Moody's cut the ratings or outlook for 40% of European real estate companies in the year to March 2023.

The problem is most acute in countries such as Finland, Ireland, Greece and the Baltic states, where more than 90% of loans to commercial real estate companies are at floating rates or mature in the next two years.

This compares to only 30% in the Netherlands and 40% in Germany.

The sharp downturn in eurozone commercial property is highlighted by a 47% drop in the number of transactions in the sector in the first half of this year, compared to the same period in 2022.

The share of bank loans to non-performing property borrowers is expected to double to 26%, the ECB said.

But he warned that this could rise to half of all loans if turnover in the sector fell by a fifth and tighter funding conditions were maintained for another two years.

The central bank said debt levels were likely to "deteriorate further as these companies' profits decline and commercial property prices appreciate downwards".

Damage to offices and shops

According to the ECB, shifts to telecommuting and online retailing have hit demand for offices and shops, weighing on rental income for property owners, while older and lower quality buildings are experiencing greater rent declines as tenants focus more in the energy efficiency of a building.

In a sign of how investors believe the price of commercial real estate has fallen sharply over the past two years, the market value of listed eurozone real estate companies has fallen from 110% of the book value of their assets to less than 70%.

Crises from imbalances in the real estate market

According to the ECB, imbalances in real estate markets can trigger financial crises, as has been observed several times in the past.

The 2008 global financial crisis is said to be the most prominent example of financial and macroeconomic instability caused by credit-fueled real estate boom-bust cycles.

It is noted that the importance of real estate markets for financial stability stems from the close relationship between the real estate sector and important parts of the economy, including the banking sector.

Damages due to corrections

According to the European Central Bank, corrections in real estate prices and reduced ability to service borrowers' debt related to high funding costs could lead to bank losses.

Rising interest rates reduce affordability and demand for real estate. This pushes down property prices and exposes banks to losses where real estate is used as collateral – increasing bank default losses.

At the same time, rising interest rates increase funding costs through higher debt service costs, and this increases the likelihood of default, particularly where borrowers face income challenges.

It is stressed that a combination of rising funding costs, falling property prices and negative income shocks for households and real estate companies could lead to banking sector losses.

Source: stockwatch.com.cy

Photo: stockwatch.com.cy