B
anks in the euro region have approximately €1.3 trillion in outstanding loans to commercial real estate investors, with credit quality "visibly deteriorating," according to a European Central Bank study on the links between CRE and the financial system. The research found that exposures are not evenly spread across banks, and smaller, specialized lenders may experience stress due to their larger exposures.

    A rise in non-performing loans indicates worsening creditworthiness, the report states. The ECB has been studying the risks posed by a CRE downturn triggered by rising interest rates. While the sector is likely too small to threaten bank solvency, earlier research highlighted widespread issues with lenders valuing collateral underpinning business real estate loans.

    A linked study on property funds found that they have struggled to sell offices after their values plummeted during the pandemic, forcing them to sell housing and warehouses to meet redemptions. This has left them exposed to the battered office market. Some funds have considered adding leverage to avoid asset revaluations and potential fire sales.

    About 5.7% of loans to real estate investment funds have soured, compared with 1.4% of CRE-related lending to firms, according to AnaCredit data. The study warns that "lending to REIFs exposes banks to losses" when markets are stressed, creating feedback loops between banks and funds that can be exacerbated by risky lending practices.

    Banks may face losses as 18% of their loans to REIFs in the euro region are unsecured, the researchers found.