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Global Financial Stability Watchdog is asking regulators to tackle the $1.2 billion commercial real estate market “vulnerability” due to high levels of debt, liquidity inconsistencies and lack of data on banking sector exposures.
The Financial Stability Committee said the commercial real estate market is more volatile than other assets, further reducing demand for office and retail space, and could lead to extreme weather and energy efficiency regulations.
The FSB warning on Thursday comes after commercial real estate investors went through a period of stress, and office demand hit the rise in remote work during the pandemic and pressure on the funding structure from higher interest rates.
Watchdog’s report concluded that commercial real estate has “survived recent unfavorable developments.” This “benign outcome” comes from the fact that the recession is only a part of the market, with some suffering borrowers refinancing and leverage levels lower than in previous crisis.
However, it warned in 2023 that bad debts on commercial real estate loans in office buildings by US and Australian banks have been “a significant increase.”
The FSB said interest rates for commercial real estate support mortgage securities (CMBs) packaged loans in the sector had risen significantly compared to other corporate loans.
“As of September 2024, the office and retail segment segment, which have the highest percentages at 12.6% and 11.2%, respectively, said “distress was apparent in multiple segments” of the CMBS market.
The financial leverage of commercial real estate investors appears to be greater than other types of non-banking companies, according to the report, which estimates that the total liability for sectors around the world is 45% of total assets.
The US, Canada, Singapore and Germany have “tails” of real estate investment funds and other real estate funds, warning that “they have a large level of leverage as their debt is at least three times more equity.”
Banks still have the most exposure in commercial real estate, worth around 8.5 tonnes worldwide, the report says. The bank said it has “complex interactions” with non-bank commercial real estate investors, and “flows into the banking system” of the risk of a real estate shock.
However, he said there is still a “substantial data gap” in the link between banks and non-bank investors in such commercial real estate, calling on regulators to close such gaps.
The FSB does not have its own legally binding authority, but it brings together the world’s top central bankers, finance ministers and regulators to agree to a common global framework of financial regulation.
When the pandemic hit, many open-ended real estate funds were forced to prevent investors from introducing cash by introducing “gates” or suspending redemptions.
The FSB said some funds still “may be vulnerable to execution as they show significant liquidity inconsistencies.” It called for the way Germany introduced minimum holding periods for real estate fund investors and Italy closed all real estate funds, asking regulators to implement measures to address such issues.
“The FSB guarantees continuous market surveillance given the more volatile performance of commercial real estate compared to other assets.”
Bank of England Governor Andrew Bailey is scheduled to serve as FSB chair next month from Kras Knott.
