I
nvestment professionals in European commercial real estate are aware that prices have weakened since markets peaked in summer 2022, following the COVID-19 pandemic. While some market segments, particularly offices, have experienced significant declines, others continue to grow. Our analysis shows that approximately 63% of assets transacted since 2017 have registered negative price movements over the two years to Q2 2024.

    The impact of recent price declines on lenders' collateral is a crucial concern. By examining market-level price-index performance and comparing it with since-transaction results, we can understand how recent price movements have affected prior price growth or compounded earlier negative trends. This analysis highlights the importance of considering transaction timing when assessing overall market change.

    For instance, the office market in Munich posted a 27% fall in price since Q2 2022, but had enjoyed cumulative 29% growth from Q1 2017 to Q2 2024. The aggregate since-transaction price fall for all assets in this market segment is much more muted at 7.4%. In contrast, the Madrid retail price index dropped 22% from Q2 2022 to Q2 2024, but prices had already fallen in the run-up to that period, yielding a cumulative drawdown of 40.7% since Q1 2017.

    This analysis is particularly relevant for real-estate lenders trying to understand how recent price falls may impact current LTV ratios on their collateral. The need for this assessment has become more pressing due to imminent banking regulations requiring banks to monitor their real-estate-loan portfolios quarterly using external market data.

    To assess the potential impact on LTVs in Europe, we took all transactions over the last seven years and used MSCI hedonic price indexes to mark to market each asset as of Q2 2024. We created a scenario selection tool that allows users to choose an assumed origination LTV and a "troubled" LTV threshold. This generates a price-movement threshold applied to a scatterplot to highlight "troubled" assets with estimated since-transaction price falls below the threshold.

    Using this tool, lenders can analyze three types of scenarios:

    * Price falls: Selecting a cell where origination LTV equals the troubled-threshold LTV produces a 0% price-change threshold showing the proportion of assets whose prices have declined since their transaction date.

    * Tightening lending criteria: Selecting a realistic origination LTV with a lower troubled-threshold LTV results in higher proportions of assets deemed troubled, even for those that had enjoyed some price growth.

    * LTV covenant breach: Selecting a higher LTV threshold associated with typical LTV covenants as a risk-monitoring process yields a lower proportion of assets deemed troubled.

    By testing scenarios on LTVs, lenders can better understand the potential impact of recent price falls on their collateral. For example, in the U.K., nearly 95% of office and 74% of retail properties transacted since 2017 experienced price declines versus their transacted prices. In a scenario of tighter lending conditions, nearly 64% of U.K. apartment property, 76% of industrial, and virtually all office and retail property could face refinancing difficulty.

    Our analysis illustrates how large swathes of property-loan collateral in Europe could be underwater or face refinancing struggles in the future. By combining price indexes with assumed origination LTVs in various scenarios, lenders can use our tool to understand better the health of their collateral pool and align with emerging regulatory requirements.