Commercial real estate debt in the eurozone is higher than pre-2008 levels, ECB warns.

The eurozone's real estate companies are suffering severe losses and some will struggle to meet their debts, which have risen to levels higher than before the 2008 crisis, the European Central Bank (ECB) has warned.

The losses, the ECB said, will have "implications for the sustainability of banks' loan portfolios" and are being driven by soaring financing costs, falling commercial property values, declining rental income and growing concerns about the energy efficiency of buildings. The central bank said signs of stress in the commercial real estate sector, which accounts for 10% of all eurozone banks' loans, "could significantly exacerbate the adverse scenario" and'''bring big losses'' in the broad financial system.

The average debt of large European real estate companies has exceeded 10 times their profits, "roughly equal to or higher than the level before the global financial crisis," the ECB indicated as part of its semi-annual review of financial stability. The full review will be published on Wednesday, but the ECB has published its concerns about commercial real estate in advance.

The ECB's interest rate hikes have hit the sector hard. The cost of financing the purchase of commercial real estate in Europe has now risen by 2.6 percentage points from its level before the rate hikes began last year, according to data from the eurozone credit registry.

Now''The ECB's benchmark deposit rate is 4%, up from minus 0.5% before the monetary policy squeeze began.

Higher borrowing costs pose a problem for the most indebted companies, the ECB said, pointing out that ratings agency Moody'\''s Analytics downgraded the ratings or outlook for 40% of European real estate companies in the year to March 2023.

The most difficult situation has arisen in countries such as Finland, Ireland, Greece and the Baltic States, where more than 90% of commercial real estate loans are at variable interest rates or close within the next two years. In contrast, the figure is just 30% in the Netherlands and 40% in Germany.

"Business models established on the basis of profitability to''pandemic and long-term low interest rates, could become unprofitable in the medium term,' the ECB warned.

The sharp downturn in eurozone commercial real estate is underscored 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 loss-making real estate borrowers is expected to rise to 26%, the ECB said.

The central bank says debt levels will "deteriorate further as company profits fall and prices for commercial'''real estate will be revalued downwards'. The shift to remote working and online commerce has hit demand for offices and stores, impacting rental income for property owners, while older and lower-quality buildings are facing large rent reductions as tenants increasingly look to the energy efficiency of buildings.

The dramatic fall in commercial real estate values in the Eurozone over the past two years is confirmed by the decline in the market value of listed Eurozone real estate companies from 110% of their asset value to less than 70%.

The residential real estate sector in Europe is also facing similar challenges. However, the ECB reports that a strong labor market is helping to maintain low levels''Mortgage defaults, while housing shortages and rising construction costs provide support for prices. - Copyright The Financial Times Limited 2023