Geopolitical events have sparked concerns of a crisis in Europe's commercial real estate sector, echoing the situation in Japan and the US. Many banking stocks worldwide, especially those with significant exposure to commercial real estate loans, saw a decline in their values last week.
The situation has become alarming on both sides of the Atlantic. New York Community Bancorp (NYCB), with assets of over $100 billion (€92 billion), 60% of which are linked to commercial real estate in Manhattan, faced negative publicity last week due to unexpected fourth-quarter losses and disappointing revenue. The situation led to a sharp sell-off on Wall Street, with its shares falling more than 50% since late January.
Europe's banking sector is also facing a similar problem. Deutsche Pfandbriefbank AG (PBB), a Bavarian real estate bank that has over a century of expertise in commercial real estate financing, was particularly affected this week. The bank announced risk provisions totaling between €210m and €215m due to "persistent weakness in the real estate market," which the institution's management described as "the biggest real estate crisis since the financial crisis."
PBB shares have fallen 17% in the past four days, with the subordinated bond falling below 40 cents on the dollar. Although this downturn has been severe, it has been somewhat mitigated by PBB's relatively modest market capitalization of €628 million.
Warnings by the ECB and Moody's
The stability of the commercial real estate sector in Europe has been a cause of significant concern for both the European Central Bank (ECB) and credit rating agency Moody's. In its latest Financial Stability Report released in November 2023, the ECB highlighted a continuous decline in retail property prices, which has been worsened by market stagnation. The ECB also reported a worrying decline in transaction activity in deals in the real estate sector, with a 47% decrease in the first half of 2023 compared to the same period in 2022. Moreover, it warned of potential solvency challenges due to a detrimental "mix" of increasing financing costs and decreasing rental incomes.
Similarly, in a summer 2023 warning, Moody's identified several critical factors exacerbating the challenges faced by the industry. Many of these issues echo the problems encountered by the US market, such as significant changes in the office industry's requirements, driven by the adoption of hybrid work models and stricter environmental regulations.
Strong downward shift in the German office market
The German office property market has experienced a significant decline in prices and returns for investors. According to recent data from the German Banking Association VDP, office property prices have fallen by 5.2% in the last quarter of 2023 and 13.3% year-on-year, marking the most significant decline since 2004. However, the retail property market is performing relatively better, with prices falling by 9% year-on-year and 3.9% quarter-on-quarter. Although retail properties have been experiencing falling prices for an extended period, new contract retail rents have risen by 2.5% year-on-year, breaking records since 2019. Retail property yields also rose by 12.7% in the final quarter of 2023, which is a new record.
According to VDP, office property yields increased by 17.5% in the final quarter of 2023 compared to the same period in 2022. However, Jens Tolckmitt, the CEO of VDP, mentioned that they have not met investors' expectations. He added that demand for office space remains low due to uncertain economic growth in Germany and ambiguous employment trends, leading to a continued fall in prices. On the other hand, new retail leases have increased for the first time in over four years, indicating that the retail market is further along in the cycle.
Tolckmitt expressed his caution about the real estate market's outlook for 2024. He said that the market remains depressed, and it will take some time to reach a new price equilibrium for buyers and sellers of real estate. Only then will we see a marked recovery in the market.
"Moreover, the demand for office spaces is currently low due to Germany's uncertain economic growth and the unclear impact of employment trends," he explained. "Therefore, the prices of office spaces are still falling. On the contrary, the retail sector is much more advanced in the cycle, as indicated by the first increase in new leases in over four years." When asked about his perspective on the real estate market for this year, Tolckmitt expressed his cautiousness. "As we enter 2024, the real estate market is still depressed, and the prices are still decreasing. It will take some time before the buyers and sellers of real estate reach a new price equilibrium, and only then will we see a significant recovery in the market," he said.
Europe's largest office REITs
- Gecina (GFC) has Europe's leading office portfolio, with almost 97% located in the Paris area, valued at €22bn.
- Inmobiliaria Colonial, SOCIMI, S.A., is a Spanish REIT focused on prime office space in Barcelona, Madrid, and Paris. Its core office portfolio is valued at over €12 billion.
- Derwent London plc has a commercial property portfolio of 66 buildings, primarily located in central London, valued at over €6bn as of 30 June 2023. It is the largest office REIT with a focus on London.
