April 26, 2023
Perspectives on the real estate market and its potential impact in the banking sector
Over the last few months, several macroeconomic and financial events have impacted the various sectors of the economy, and the real estate market has not been immune to these movements. With that arose the debate about how much risk there is in investments focused on real assets, whether through equity or debt. Additionally, the Silicon Valley Bank (SVB) debacle exposed the risk that banks currently have within their portfolios to debt focused on commercial real estate, adding uncertainty to investors.
Now, how is the real estate sector classified? The traditional classification consists of 4 subsectors: housing (for rent and purchase), industrial and logistics, offices, and retail. This classification is essential since, in each sector, there is a particular dynamic; in the first place, the housing sector is in the process of a slowdown in the buying and selling market, driven mainly by the increase in reference rates, impacting the cost of acquisition of properties. However, this slowdown allows potential buyers to migrate to the rental market. According to data from CBRE, in 2022, the level of rents increased by 9.2%, a positive sign of a growing market. Although valuations may decline, the need for housing and rising rents will provide a hedge in this segment. The industrial and logistics sector is in a clear upward trajectory; on the one hand, the change of consumer trends towards digital commerce, and on the other, the reconfiguration of different dynamics in international trade has exacerbated the demand for industrial assets in different cities, with occupancy levels at historical highs, stable valuations, and increasing level in rents.
Although the previous sectors have a more defensive outlook, the office and retail sectors are more uncertain. Fundamentals in the office sector are weak; according to information from JP Morgan, vacancy and availability rates reached 12.5% and 16%, respectively, maximum levels since the global financial crisis; In addition, national income growth continues to decelerate, at 1.1% in nominal terms and -5% in real terms. Given the negative dynamic in these sectors, one of the main risks focuses on the debt issued. According to information from Trepp, there is a total of $ 4.4tn of loans payable, of which 38% has banks as counterparties. If we do not consider the multifamily housing sector, the amount owed is $ 2.5tn, of which 44% is in the hands of banks.
According to JP Morgan, applying an 8.6% loss rate on total exposure, potential losses for banks could be up to $38bn and $16bn for insurers.
In conclusion, the dynamics of the real estate sector show mixed expectations. On the one hand, the rental housing and industrial and logistics sectors have positive fundamentals that will allow them to navigate a potential economic slowdown with more stability. In contrast, the office and retail sectors have begun to show negative dynamics, with lower levels of occupancy, increased vacancy rates, and depreciation in pricing. Finally, the financial sector could be affected in an adverse scenario as it is the leading lender of real asset investments.