Et tu central banks
Last week saw central banks add their voices to an increasing consensus all is not well in the commercial real estate sector. The European Central Bank released a white paper warning how overly liquid real estate investment funds, which it says account for 40 percent of Europe’s commercial property asset base, present a systemic risk to “the wider financial system and the real economy”. To illustrate its concern, it pointed to the redemption issues at Blackstone’s largest real estate vehicle, BREIT – which PERE covered extensively – as a “recent stress event outside the euro area.” The REIT saw an uptick in its redemption requests in March too, rising to $4.5 billion from $3.9 billion in February.

Meanwhile, in Australia, the country’s Reserve Bank said falling valuations and weaker demand for offices coupled with rising borrowing costs are heaping pressure on its commercial property market and could potentially expose vulnerabilities in its banking sector. According to the RBA’s semi-annual Financial Stability Review, released last Thursday, Australian property is not highly geared, but that situation could easily change if “declining valuations lead to markdowns of the book value of their properties,” adding “some landlords are likely to become financially distressed.”

Coming to a city near you
The woes faced by owners of out-of-favor offices are well known, with several headline loan defaults contributing to a steadily rising delinquency rate. Indeed, data from analytics firm Trepp shows the US office rate saw a sharp uptick in March to 2.61 percent. Despite this, the level of distress has been relatively muted thus far, and has primarily occurred in US markets such as New York and Los Angeles. According to Bloomberg Intelligence, however, this could be about to change. Research published last week claimed that if office values in major European cities fall by at least 20 percent and interest rates stay high, there could be widespread distress to loans taken out in the past five years with short maturities. With office values in London, Paris and Berlin having fallen back near to levels circa 2017, such properties will be harder to refinance, said analysts, particularly in locations with vacancies of 10 percent plus such as London’s City. For insight from the appraisers on how the revaluation of office might play out, read our latest coverage.

Mixed views on lower rates
Although the Federal Reserve is anticipated to start cutting interest rates in H2 2023, lower rates are necessarily not the cure-all for the financing woes currently afflicting the commercial real estate industry, according to a Bank of America research report published last week. “Lower interest rates, holding all else constant, would be positive and could help alleviate some of the concerns we have about borrowers’ ability to refinance over the next year,” wrote US CMBS analyst Alan Todd in the report. However, financing costs are unlikely to decrease significantly. Credit risks will remain elevated since lower rates would likely be an indicator of a weaker economy, he said. Moreover, while lower interest rates would benefit borrowers with higher-quality properties, “we think borrowers with lower-quality properties or those backed by out-of-favor property types – office, for example – may still face significant headwinds.”

Data snapshot