Commercial Real Estate Sector Faces Risks as Financial Conditions Tighten

IMF Blog, September 22, 2022

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Canonical URL: Commercial Real Estate Sector Faces Risks as Financial Conditions Tighten

Authors: Andrea Deghi, Fabio Natalucci, Mahvash S. Qureshi
Date: September 22, 2022
Summary finding: Aftertaking a hitat the onset of the pandemic, the commercial real estate sector—properties primarily owned for investment purposes—has been on the mend, but momentum is losing steam as global financial conditions have tightened this year as central banks shift to hiking interest rates.
Observation: Prices of industrial and residential properties have surged globally since the end of 2020, while the worst-affected retail and office segments have shown some signs of stabilization.

Financial conditions are an important driver of commercial property prices and help explain recent divergence across market segments and regions.
Direct channel: Tighter financial conditions make it more expensive for investors to finance new deals or refinance existing loans, lowering investment in the sector.
Indirect channel: Tighter conditions can slow economic activity, reducing demand for commercial property such as shops, restaurants, and industrial buildings.
Cross-country observations:
- Economies with easier financial conditions (that is, lower real interest rates and other market conditions that make it easier to obtain financing) saw a smaller decline in commercial property prices during the pandemic and a faster recovery.
- Commercial property prices have also been higher in countries which implemented relatively less stringent public containment measures to control the spread of the virus, rolled out larger fiscal support packages, and have a higher vaccination rate.
Recent trend: Property prices in the industrial and residential segments have, on average, experienced a deceleration across regions in recent months; depreciation in retail and office property prices has increased.

Identified trends affecting demand and prices:
- Increased teleworking tends to reduce demand for office space.
- E-commerce adversely affects the price of retail real estate as consumers shop online.
Interaction with financial conditions: Considerable uncertainty about the future pace and extent of these structural shifts means tighter financial conditions could compound effects and exacerbate downward price pressures in affected segments.

Risk channel: Disruptions in the commercial real estate market could potentially threaten financial stability through the connectedness of the sector with the financial system and the broader macroeconomy.
Supervisory and macroprudential recommendations:
- Continued vigilance by financial supervisors is warranted to mitigate such risks.
- To ensure banking-sector resilience, stress-testing large declines in commercial real estate prices should be conducted to inform decisions regarding the adequacy of capital buffers for commercial real estate exposures.
- Banks’ commercial real estate valuation assumptions should be reviewed to ensure that provisions are adequate.
- In regions where nonbank financial institutions are important players in commercial real estate funding markets, efforts should focus on broadening the reach of macroprudential policy to cover these institutions to mitigate systemic risks.

The IMF, based in Washington D.C., is an organization of 191 countries, working to foster global monetary cooperation and financial stability around the world.
IMFBlog is a forum for the views of the International Monetary Fund (IMF) staff and officials on pressing economic and policy issues of the day. The views expressed are those of the author(s) and do not necessarily represent the views of the IMF and its Executive Board.

Source: Commercial Real Estate Sector Faces Risks as Financial Conditions Tighten (IMF IMFBlog), September 22, 2022.