European commercial real estate: a ticking time bomb?

By Natixis CIB cross-expertise Research | Reading 8 minutes

When it comes to the outlook for commercial real estate, red flags have multiplied in recent months. The sector finds itself caught between, sticky inflation on one hand, which, by driving up interest rates is impacting real estate valuations and refinancing costs, and a weakening economic outlook on the other hand, weighing on rental growth and increasing vacancy rates.

Decline already under way… but with few transactions

With a 60% fall in transaction volumes year-on-year in Q1-23, the decline in commercial real estate investments was the first sign of the trend reversal taking hold, especially in Europe.


Further, real estate valuations started to decline in Q3-22, marking the end of a nearly uninterrupted rise since 2009. Residential real estate and offices should be the most impacted, whereas the shopping center segment is expected to be the most resilient, as the correction in retail property values started well before other segments, with the advent of “retail bashing” and the threat posed by e-commerce.


Based on our experts’ modelling of prime yields or real estate valuations in Europe, we expect to see a 20%-30% decline in the case of offices, a decrease of 13%-23% in the case of logistics and a drop of 9%-20% in the case of shopping centers, relative to levels observed at the end of H1-22.

Which real estate investment companies are most at risk of a rating downgrade?

Real estate investment companies will be directly affected by the deterioration in their leverage and coverage ratios. Increasing investor concern about the extent of the deterioration in their credit ratios (LTV, ICR) caused the debt market to seize up, and was exacerbated by the fact that many had planned to deleverage through asset disposals.


Our experts analyzed 22 Real Estate Investment Trust (REIT) companies and identified the main issuers at risk of a rating downgrade.They conclude that 6 of the 22 REITs analyzed have significant risk of a ratings downgrade. On a more positive note, none – save for one in Sweden – appears to be at risk of breaching bank covenants.

Do CRE exposures present a risk for European banks?

With 7% of total loan books exposed directly to commercial real estate (CRE), European banks appear less exposed than their US counterparts. Efforts have been made by banks to bring down LTV ratios, averaging 49% in 2022 against around 75% in 2010, but the situation remains very diverse, depending on the country and issuers.


European banks will have to set aside an additional €30bn in provisions to cope with potential losses in the short-to-medium term, while the negative impact on capital will be an average of 80bp in CET1.

A likely limited impact for insurers exposed to commercial real estate

10% of European insurers’ (excluding British insurers)  investment portfolios are exposed to real estate. Based on disclosures by insurers, our experts have attempted to estimate the total exposure of European insurers to commercial real estate, taking into account their exposure to physical real estate as well as their interests in REITs.


Overall, the low weighting of commercial real estate in investment portfolios, as well as solid solvency ratios displayed by European insurers (average solvency ratio of more than 200%) will enable them to absorb the shock coming from the expected decline in commercial real estate valuations. The fall in excess of assets over liabilities would be limited to 10% on average. However, a collapse of the commercial real estate market could jeopardize the solvency of smaller insurers.

Covered bondholders do benefit from several protection mechanisms

25% of covered bond programs are backed by commercial and residential mortgages, with Pfandbriefe (bonds based on earnings from mortgages invested in other financial products) being overexposed to commercial loans. Our experts estimate the current sensitivity of covered bond spreads to commercial loans at just 2bp but would expect this to increase going forward.


Despite a deterioration in the credit quality of commercial loans, covered bondholders do benefit from several protection mechanisms, such as conservative LTV ratios, high over-collateralization, active management of cover pools and a recourse on both the cover pool and the asset of the sponsoring bank.

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