According to the latest report on the real estate sector by the European Central Bank, weak profitability prospects are creating increased downside risks in the portfolios of European banks exposed to the commercial real estate market. The report specifies that the sector in the Eurozone could face difficulties for years, thereby exposing bank loans, investment funds, and insurers.

Given the limited size of banks’ commercial real estate portfolios and lower exposure compared to the residential market, it is unlikely that these alone could cause a systemic crisis at the Eurozone level. However, they could amplify shocks in the financial system and have a significant impact on financial companies.

The report notes that residential mortgages represent approximately 30% of bank loan portfolios, while commercial properties account for about 10%. It also emphasizes that economic weakness and high interest rates have depressed property prices over the past year, reducing the profitability of real estate companies.

Commercial real estate transactions decreased by 47% YoY in the first half of 2023, making it difficult to determine the extent of the price decline. However, the largest listed property owners in the bloc are traded at a discount of over 30% compared to net asset value, marking “the largest discount since 2008.”

According to a sample of bank loans to real estate companies, the recent increase in financing costs could result in the proportion of loans granted to loss-making companies doubling to 26%. If, as expected, more restrictive financing conditions persist for two years, and companies are required to renew all maturing loans, this percentage would increase to 30%. 53% of the sample loans would be directed to companies incurring losses if the companies simultaneously experienced a 20% drop in revenue.