Why banks are still concerned about commercial real estate

Since central banks began aggressively raising rates to combat rising inflation, commercial real estate has become a key area of concern. Rising interest rates and a reduced need for office space (due to the effects of working from home) have resulted in higher vacancy rates and lower real estate values. While the worst of the price declines have leveled off, concerns remain about more challenging financing terms and that high commercial real estate debt maturities will continue to put pressure on the commercial real estate sector, which is heavily dependent on debt financing.

The increased presence of investment funds in commercial real estate adds additional concerns, especially if these companies must sell properties to pay off upcoming debt maturities. Real estate investment is declining and climate transition risks loom, but it is reassuring that rent growth remains stable. Banks are also much better capitalized now than they were during the financial crisis. However, observers remain vigilant about the potential stresses that could arise in the commercial real estate sector, especially if interest rates remain high for an extended period in an uncertain geopolitical, inflationary and economic environment.

The worst price declines

The worst of the price decline seems to be over in the EU-15 commercial real estate market. Nordic banks are most exposed to commercial real estate firms.

The degree of exposure, however, varies considerably from country to country. In Nordic countries such as Sweden and Denmark, loans to commercial real estate companies account for 57% and 67%, respectively, of banks' loans to non-financial sector companies. In Spain and Italy, only 10% and 13% of banks' corporate loan portfolios are loans to commercial real estate companies.

Despite Nordic banks' significant exposures to the commercial real estate sector, the performance of these loans remains stable for the time being. Swedish banks report the lowest insolvency rates for their commercial real estate-related loans, closely followed by Nordic banks from Norway, Finland and Denmark. Austrian and German banks also report moderate insolvency rates for their loans to commercial real estate companies. The highest insolvency rates are associated with Polish, Estonian, Portuguese and Irish banks.

Nordic banks have high exposure to the commercial real estate sector but low default rates.