Almost $175 billion in real estate loans are already in default, according to data compiled by Bloomberg. As the damage from higher interest rates and the end of easy money mounts, many real estate markets are nearly frozen. Some lenders are even telling borrowers to sell assets or risk foreclosure amid demands for additional capital from landlords.
European real estate woes are at their highest level in a decade, partly due to a drop in liquidity, according to a survey by law firm Weil, Gotshal & Manges. UK commercial property values fell by more than 20% in the second half of 2022. In the US, the drop is around 9%.
The decline in commercial and residential property transactions and developments will inevitably affect spending in the real economy. In turn, this could pose a risk to jobs and growth.
“This year, these problems will begin to manifest themselves. About one in 10 corporate loans in Europe are already delinquent and have increased credit risk, according to JLL.
The sudden stop to easy money, which lasted for more than a decade, made the situation worse for property companies. The pandemic, which has changed the way people work and live, has left many commercial real estate owners in the lurch.
The consequences are felt around the world. Real estate arm Brookfield warned in November that it may struggle to refinance debt on two towers in downtown Los Angeles and raised the possibility of a foreclosure, which analysts called “worrying” for the market. A default on debt by the company building the Legoland Korea theme park sparked a credit crunch in the country, forcing the central bank to act to stabilize markets.
“We expect to see some casualties” among UK companies, said Nicole Lux, who studies real estate lending at Bayes Business School. “There will be fire sales,” she added.
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Commercial real estate – from offices to shopping centers – is more sensitive to economic conditions than other asset classes, said Andreas Dombret, who sat on the boards of Germany’s Bundesbank and the Bank for International Settlements, adding that “in the past, when the bubble spuka, very often it was related to commercial real estate.
“But it’s always so hard to crash the party,” Dombret added. “This is why regulators often avoid introducing countercyclical buffers at the right time: when there is no stress in the real estate market.”
Higher interest rates for new loans
Signs of a US slowdown are mounting. But despite the decline, commercial property values are “still moderately overvalued,” said Michael Knott, head of US REIT Research at Green Street, who expects another 5% to 10% drop this year.
Several US banks forecast that loan losses will rise this year. In its fourth-quarter results, Bank of America Corp. noted an additional $1 billion in loans for office properties, such as those at increased risk of default or missed payments.
The turnaround has been so rapid that some private lenders are already struggling for liquidity, said Tom Capas, chief executive of real estate finance firm Ready Capital, adding that the company is looking to “buy other people’s problems,” including loans for construction.
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Two fires raging at the same time
The pressure on commercial properties is expected to be felt on both sides of the market – older buildings where tenants have moved out and buildings under construction that are not yet completed. The second phenomenon is most pronounced in China. In September, the construction of 2 million homes was halted due to the slowdown in the property market.
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