Vulnerabilities in commercial real estate have begun to emerge as the European Central Bank (ECB) has raised interest rates and while the banking supervisory body tracked the exposure of European entities. The effects of monetary tightening are visible, with Germany once again being pointed to as the sick man of Europe. Among the affected are Austria and the Netherlands, but not Spain, which seems to be immune to the crisis in the sector.
The ECB has found significant weaknesses in European commercial real estate. The organization has been tracking the sector for some time, conducting specific assessments on potential victims of high interest rates and their respective lenders, conducting thorough investigations and inspections on site. After two years of active supervision, the ECB, for example, came across the case of Signa. The Austrian real estate firm experienced the sector’s biggest bankruptcy since the global financial crisis last year.
“It’s our daily bread,” said Andrea Enria, the former head of banking supervision at the ECB, at the end of last year, about the fieldwork they have done throughout Europe since they noticed the fall in brick valuations. At that time, the Italian explained that the investigation into Signa was one of the hundreds they were conducting and that they had planned 130 more inspections in the future.
The monetary authority has been asking the affected parties to take precautions. It has asked banks burdened by companies like the Austrian to register losses on their balance sheets, so that the real impact of the commercial real estate crisis on banking can be seen, and to increase their provisions. Swiss entity Julius Baer was one of those that had to increase its cushion in the face of Signa’s insolvency and disclose its exposure to it, around 620 million euros.
Throughout this scrutiny and beyond René Benko’s real estate empire, the regulator has found vulnerabilities in Germany, Austria, and the Netherlands. But not in Spain. Thatcountry remains unaffected by the problems plaguing other neighbors, and for now, there is no risk of contagion. “Unlike other jurisdictions, there are currently no significant risks detected in the commercial residential sector in Spain,” explained the director general of Financial Stability at the Bank of Spain (BdE), Ángel Estrada, at a real estate sector event last week.
Although risks are accumulating in real estate, Spain’s exposure is relatively low and no significant imbalances have been found, Estrada said in his presentation. While the national picture seems healthy, in other member states, high interest rates, teleworking, or online commerce are having a significant impact on the sector.
The most leveraged property owners are having trouble meeting their financial obligations as debt becomes more expensive. In Europe, 70% of financing in the sector is at a variable interest rate. Additionally, when property prices fall, the percentage of debt to value automatically increases (LTV ratio), putting pressure on the asset itself. In buildings such as offices or shops, reduced foot traffic means their owners earn less income just when they have to pay higher interest.
According to the BdE report, loans to developers and construction companies make up 8.3% of eurozone bank credit. However, countries like Germany, the Netherlands, and Italy have exposure above the European average. Of the examples cited, Spain has the lowest percentage of debt granted to real estate, below 5%.
In recent years, real estate has appreciated more in Europe’s wealthier countries, where there was money and savings to invest in brick and mortar. These transactions were financed with cheap money until the summer of 2022 when the ECB started raising interest rates. The conditions facing the sector began to toughen, and problems have surfaced among the most indebted.
For example, Aroundtown is another real estate company that invests in Germany, the Netherlands, or London that is in focus for its vulnerabilities. Just a year ago, it decided to cancel dividends due to “market uncertainty,” they said. The company has incurred losses in the 2023 financial year. Aggregate Holdings and Adler are other firms experiencing a similar situation, pressured by their debt levels after a period of aggressive expansion.
Last month, ECB Vice President Luis de Guindos said the transmission of monetary policy continues as planned and will still materialize, which poses challenges for some sectors, especially commercial real estate. “The sector’s vulnerabilities pose risks to the financial system,” he said, although he believes banks are better prepared than other financial institutions for regulatory reasons and for “robust” oversight.
As de Guindos pointed out, everything depends on the effects of monetary tightening. Currently, the ECB’s central scenario is for improved financing conditions as interest rates have peaked, with cuts expected this year. Initially, several ECB members have pointed to June for the first rate cut. This would imply a significant improvement in the financial situation of real estate companies, according to the aforementioned BdE report.
However, if interest rates end up being higher than currently expected and company results deteriorate, negative effects would be seen. At the same time, there is a risk that inflation, which up to now has been on track, could increase, leading to further monetary tightening.
The ECB is confident that the supervision it is conducting will serve as a preventive remedy in cases where it has detected more vulnerabilities. The institution argues that the investigations it has carried out in companies like bankrupt Signa are common and have been taking place for a long time across Europe and the sector. For now, Spain appears free from contagion.
