The commercial real estate sector in the euro area could face difficulties for years, which poses a threat to the banks and investors who finance it, according to a report published on Tuesday by the European Central Bank, according to Reuters and Agerpres.

Blocks under construction in GermanyPhoto: Guido Schiefer / Alamy / Profimedia Images

The European housing market is under pressure after the ECB significantly raised interest rates, which are now at record levels, and the economy is slowing down.

The ECB report examines threats to financial stability, highlighting major concerns about the effects of the housing boom now causing problems in countries such as Germany and Sweden.

According to the ECB, commercial property prices are affected by economic weakness and interest rate hikes over the past year and represent a threat to the banking sector’s profitability and business model.

The real estate sector is waking up to a different reality after a period of “boom” in the EU

The commercial real estate sector in the euro area is not large enough to pose a systemic risk to lenders, but it could increase shocks to the financial system and deeply affect financial firms, from investment funds to insurance companies, including the shadow banking sector .

“Although the relatively limited size of commercial banks’ real estate portfolios implies that a systemic crisis is unlikely to occur, these developments could play a significant amplifying role in the event of wider pressures on the market,” the ECB’s assessment report states financial stability.

Residential mortgages make up about 30% of banks’ loan portfolios, while commercial real estate loans make up nearly 10%.

“A negative evolution of these loans will lead to major losses in other parts of the financial system, for example investment funds and insurance companies,” warns the ECB.

Against the backdrop of low interest rates and massive liquidity injections by the ECB, billions of euros have been invested in the real estate sector in the last decade, especially in wealthy European states such as Germany, France and the Netherlands.

The rapid increase in inflation over the past two years has forced the ECB to raise interest rates, which has halted property price growth, with many developers going into insolvency. Banks in the euro area have reduced access to loans, especially mortgage loans, and demand from households and companies is decreasing, ECB data show.

The ECB fears that some banks are not sufficiently prepared for a shock

Last month, the European Central Bank asked real estate appraisers to explain the methodologies they use, amid mounting concerns that the region’s banks have been far too slow to write down the value of commercial real estate loans on their balance sheets.

According to sources who wished to remain anonymous, the exchanges of information in recent months are part of a wider effort by the ECB to identify potential hits to banks.

Even though banks have built up provisions for possible losses on commercial real estate loan portfolios, it is possible that the banks will suffer further losses if the valuations assigned to these portfolios turn out to be outdated, the sources said.

Some banks have turned to commercial real estate lending over the past decade to boost revenue as negative interest rates eroded their profitability.

But the asset class has been hit by the expansion of home working and online shopping during the pandemic, and rapid interest rate hikes over the past year have further dampened demand for commercial real estate.