Tuesday, May 18

Introduction and Moderator
Mr. Reiner Martin, Lead Economist, Joint Vienna Institute

Panelists
Mr. Andrea Deghi, Financial Sector Expert, International Monetary Fund
Mr. Junghwan Mok, Economist, International Monetary Fund
Ms. Ellen Ryan, Financial Stability Expert, European Central Bank

The COVID-19 crisis has hit the global and European Commercial Real Estate (CRE) sector hard and increased uncertainty about the outlook for some of its segments due to possible structural shifts in demand. While there was little evidence of large price misalignments at the onset of the pandemic, signs of overvaluation have now emerged in some economies. Such misalignments increase downside risks to future growth due to the possibility of sharp price corrections, especially if they interact with other financial vulnerabilities. Such corrections could in turn threaten financial stability and hurt corporate investment, hampering economic recovery.

Against this backdrop, the webinar reviewed and discussed CRE developments more than one year after the start of the pandemic.

Mr. Andrea Deghi and Mr. Junghwan Mok (both IMF) looked at financial stability risks stemming from CRE during the COVID-19 crisis and beyond. They recalled that the CRE sector is amongst the hardest hit by the COVID-19 crisis. Especially retail, hotels, and office segments have been suffering from large declines in demand. It is also a highly procyclical sector and relevant to financial stability due to the significant exposures of banks and other (often highly leveraged) investors. Adverse shocks to CRE prices can damage bank solvency and reduce investments by nonfinancial corporations. The presenters argued that CRE price misalignments have increased during the pandemic and can exacerbate downside risk to GDP growth. In addition, going beyond its immediate adverse impact on the sector, the pandemic may exacerbate pre-existing CRE trends such as the decline in brick-and-mortar retail and increased remote working practices. Taken together, this poses significant medium-term challenges and valuation uncertainty for some CRE segments. Policies can mitigate the macro-financial stability risks associated with the CRE sector. The presenters argued that at the current juncture, continued policy support remains warranted to stimulate aggregate demand and aid the recovery of the sector. Once the extent of structural changes due to the pandemic becomes clearer, targeted macroprudential policy (such as limits on the loan-to-value and debt-service-coverage ratios) should be swiftly deployed to tackle pockets of elevated vulnerabilities. Moreover, given the increasingly important role of nonbank financial institutions in the CRE market, efforts should be undertaken to broaden the reach of macroprudential policy to cover nonbank financial institutions.

Ms. Ellen Ryan (ECB) looked at the implications of the COVID-19 crisis for EU CRE. She pointed out that the outbreak of the crisis saw activity in EU CRE markets drop sharply, with 25% fewer transactions in 2020 than in 2019. Both model and market based indicators suggest that a substantial price correction may occur as market activity resumes and traditional price indices are also beginning to show this correction. For now the retail CRE sector is already showing large price correction. At the same time, industrial CRE is outperforming the market, which is the flip-side of the e-commerce trend. The office sector of CRE is also badly affected and market intelligence suggest a “K” recovery with prime properties outperforming the general office sector. In some EU countries, the banking systems have sizeable and risky exposures to CRE markets through direct exposures and the widespread use of CRE as collateral. In the banking sector, credit risk and adequate provisioning for CRE exposures should thus be monitored closely as the impact of the COVID-19 shock continues to materialize. Going beyond the banking sector, real estate funds show sings of increasing vulnerabilities, which may accelerate as the shock becomes more apparent on fund balance sheets.

Reiner Martin, Lead Economist, JVI