European Commercial Real Estate could plummet 50% next year

Analysts at Citi now see European property stocks falling 20%-40% between 2023 and 2024 due to the impact of higher interest rates. In a worst-case scenario, the higher-risk commercial real estate sector could plummet 50% next year.

With the recent banking crisis in Europe, concerns are growing about the health of the commercial property market. Investors are questioning whether this could be the next area of stress, with higher interest rates raising borrowing costs and depressing the value of the real estate market. This is particularly worrisome as the real estate market has dominated in recent years amid low bond yields.

The collapse of Silicon Valley Bank (SVB) and the ensuing emergency rescue of Credit Suisse have raised concerns about a "loop of death" in which deposit withdrawals occur, potentially causing a series of events that could lead to a recession in the real estate sector.

European Commercial Real Estate could plummet 50% next year

The European Central Bank (ECB) has also warned of "clear signs of vulnerability" in the property sector, citing "a decrease in market liquidity and price adjustments" as reasons for concern. The ECB has called for new restrictive measures on commercial real estate investment funds to mitigate the risk of a liquidity crunch.

This has resulted in European funds that invest directly in real estate recording outflows of £172 million ($215.4 million) in February, a stark contrast to the nearly £300 million inflows recorded in January, according to Morningstar Direct data.

The office segment, a major component of the commercial real estate market, has emerged as a hub of concerns about a potential recession due to broader changes to telecommuting or ending working patterns brought on by the Covid pandemic.

According to Goldman Sachs, commercial real estate accounts for about 25% of US banks' outstanding loans, while the figure rises to 65% at smaller banks and has been the focus of recent tensions. This compares with about 9% among European banks.

Despite the high occupancy rate data of 7% at the end of 2022, much lower than the 19% in the US, analysts warn of uncertainties in the sector. Traditional European banks would lend 80% of the value of a building before the global financial crisis, but now rarely exceed 60%.

Furthermore, the upcoming EU and UK energy efficiency standards will require significant investment, particularly in older buildings, which could put additional pressure on property owners in the coming years.

Overall, there are various factors at play that are causing concerns around the health of the European commercial property market. With the ECB warning of "clear signs of vulnerability" and analysts predicting potential stock market falls, investors should closely monitor the situation and take measures to minimize risk.