Big banks are more at risk of a commercial real estate meltdown than people think, new study says

Big banks are more at risk of a commercial real estate meltdown than people think, new study says
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Commercial real estate properties could be in for another 10% decline this year, Capital Economics estimated.

  • Big lenders are more exposed to commercial real estate than it might seem at first glance, a study says.
  • In addition to lending to property owners, big firms also offer indirect lending to REITs, raising their exposure by about 40%.
  • Wall Street has been worried about distress in commercial real estate amid high interest rates. 

Leading lenders have greater exposure to commercial real estate debt than typically understood, implying a larger chance of systemic risk, according to a new study.

The paper, titled “Shadow Always Touches the Feet: Implications of Bank Credit Lines to Non-Bank Financial Intermediaries,” notes that while most analysts have focused narrowly on bank balance sheets, banks also contribute credit to real estate investment trusts, a form of indirect lending to the commercial property sector. 

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When accounting for this, bank exposure to commercial real estate debt rises by about 40%.  

Concerns about systemic risk in commercial real estate have risen sharply in recent years, as high interest rates and waning demand have sown doubt over the market’s ability to pay back debt. 

Given that regional banks are the biggest providers of such loans, unease has grown about the possibility of an extensive debt fallout sparking a banking crisis. 

When accounting for REIT credit lines and term loans, these concerns should also be applied to Wall Street’s biggest dealers, the study’s authors wrote: 

“As credit lines can be drawn intensively by CRE REITs in times of aggregate stress, collateral damage to the largest banks from such drawdowns implies that systemic risk arising from CRE exposures is likely to be considerably greater than implied by direct CRE exposure of banks,” they wrote.  

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Direct and Indirect CRE exposure

REITs are firms that buy and operate commercial real estate, selling shares to investors who want to gain exposure to the space. 

However, these vehicles are often debt-dependent and are vulnerable to high interest rates. In the past two years, even REITs sponsored by some of Wall Street’s biggest firms have had to contend with antsy investors. 

These investment vehicles have seen a rise in redemption requests, putting pressure on REITs to tap banks for more credit, the study noted. In fact, credit lines have been growing at a much faster clip than other forms of borrowing, with significant implications for lenders if a crisis strikes

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“The drawdowns from these commitments substantially weaken banks, with the markets failing to offer a commensurate reward or banks charging adequately in credit line fees,” the authors wrote. 

They added: “We find that ignoring the unique properties of REITs as a borrower class could underestimate the capital needed in the US banking system by a substantial 37%,” 

Read the original article on Business Insider

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