Andreas Dombret: An overview of the CRE (Commercial Real Estate)
market
Contribution by Dr Andreas Dombret, Member of the Executive Board of the Deutsche
Bundesbank, as Lead Discussant at the FSB (Financial Stability Board) Workshop on
Commercial Real Estate Underwriting, Frankfurt am Main, 8 May 2013.
* * *
Ladies and gentlemen
I am delighted to welcome you to the FSB workshop on commercial real estate underwriting
practices on behalf of the Deutsche Bundesbank. We are very happy to host this important
FSB event here in Frankfurt.
I am very pleased that so many dedicated real estate experts from a variety of FSB member
countries and institutions, from standard setting bodies and from the private sector
participate today. I am sure that the gathered expertise will lead to fruitful discussions and
provide for interesting insights.
Let me now start this session by sharing my views on global commercial real estate
financing. I will touch on two issues in the following minutes: first its relevance for banks and
other participants in the financial markets and second its implications for financial stability.
One of the reasons for the financial crisis was the US sub-prime crisis caused by lax lending
practices and overheating residential real estate markets. The FSB has completed
considerable work in this area, which mounted in FSB Principles on Sound Residential
Mortgage Underwriting Practices. The question about the other and perhaps even more
important part of the real estate lending business will be dealt with in this workshop: Could
excessive risks from commercial real estate financing negatively affect financial stability?
(slide)
The global stock of commercial real estate is estimated at 31.2 trillion U.S. dollars as of
2011. About two thirds of global total stock is considered to be investable. The majority of
investable stock is already invested and accounts for more than 12 trillion U.S. dollars. This
part is in the primary focus of this workshop. Taking into account the market share of
commercial banks it is not surprising that for example European banks have an estimated
total CRE lending exposure of 2.4 trillion Euros. But let me stick to the CRE markets for a few
more moments before I will turn to the lenders and banks. (slide)
Since 2007 we have seen a divergent development of CRE prices among the G20 countries.
South Africa, Canada and Korea are the only countries that show an increase of CRE prices
since 2007. Contrary to them most other countries suffer from a more or less strong
deterioration of CRE prices. Just to name a few: U.S. -19%, UK -23%, Spain -29% and
Ireland -67% between 2007 and 2012. Recently, there are signs of stabilisation or even an
upward trend. However, a rapid rebound of CRE prices in most G20 countries to a pre-crisis
level seems unlikely in the short-term.
If I look at the development of prices and the annual investment activity at once I can see
certain coherence between the two. (slide)
While global invested volumes fell by two thirds from 2007 to 2009, they almost doubled after
that in only two years to almost 400 billion U.S. dollars. Unsurprisingly, invested volumes for
Asia-Pacific have gained tremendous market share over the last few years and are now at
the same level as for Europe and twice as high as for North America. (slide)
Having the pleasure of welcoming all of you here in Frankfurt - Germany's banking city - I
would like to take the opportunity to briefly give you some insights into the German CRE
market. Germany has seen a moderate development of CRE prices over the last decade.
However, the CRE market and consequently CRE prices - unlike most other European
markets - have benefited from the economic conditions here. Foreign investors have
stepped up their investment activity over the past two years.
Leaving Germany and taking a global view again the question is, what is the state lenders
and investors are in? (slide)
Obviously, falling prices have not failed to leave a mark on both. An enormous half of
investors in EMEA and 75 percent in North America are in talks with banks on loan
amendments and/or loan extensions. If restructuring or extension of the loan is not possible,
investors must find other sources of capital for equity injections or partial loan repayments
and if this fails even asset sales are on the agenda. Clearly challenging times for investors
and following them, the lenders. (slide)
The latter have chosen a very selective path in financing CRE, lately. A more cautious
underwriting practice and tighter lending standards can be observed. According to the survey
of lenders for DTZ' global research, a preference for less risky investments was identified.
Prime assets are in favour of lenders, whereas speculative developments and non-prime
assets are currently not part of their strategic agenda. This trend of consolidation is also
reflected in new lending, where only a minority of survey respondents expected expansion of
business in 2012, while more than a third wanted to reduce CRE lending. In addition,
underwriting terms and conditions were expected to further tighten in 2012. However, for
2013 lenders expect some relaxation of lending practices back to rather normal levels, which
can be interpreted as a positive sign.
Now, let me draw your attention to an important aspect of CRE financing - the CMBS
markets. (slide)
We have seen deteriorated CRE prices, selective lending practices, and investors being in
talks about workout with their lenders. Based on this the future does not look promising from
the point of view of financial stability. If we look at maturity dates for CMBS, there are 40 to
50 billion U.S. dollars a year to be refinanced globally until 2020. The U.S. accounts for the
majority of these maturing CMBS. However, the remaining countries, among them the U.K.,
Germany and Japan are most important, account for the other half of maturing CMBS until
2020.
Numerous times the question about a funding gap was raised. For Europe alone, DTZ
Research looked beyond CMBS and identified a funding gap for all commercial real estate
for the years 2012 to 2014 that exceeds 100 billion U.S. dollars.
So, who is going to fill the gap? (slide)
In Europe and the U.S. more than half of CRE financing is provided by commercial banks.
Insurers account for more than 10 percent in both regions. In the U.S., ABS issuers gained
importance over the last 20 years and account for more than 20 percent of the market today,
according to the Federal Reserve. CRE financing markets can be described as fragmented,
but they are still dominated by the banking sector. The current weakness of the banking
sector calls for non-bank financiers such as insurers and pension funds. Moreover, the
impact of regulatory initiatives such as Basel III and banks' need to deleverage will affect
CRE lending. Weak securitisation markets put additional pressure on CRE markets.
Although banks are the most important providers of finance to the CRE market, CRE loans
only account for 10 to 15 percent of the loan book globally. Although individual shares may
differ greatly, certain trends can be observed. In the U.S., CRE loans add up to more than
20 percent of banks' loan portfolios while for example in German banks they only account for
7 percent on average. However, the range for German banks varies and can be as low as 2
but also as high as 25 percent for an individual bank. (slide)
In conclusion, let me highlight the key aspects I would like to see considered in the context of
commercial real estate financing. You have seen, that CRE tends to be more volatile.
Moreover, global and adverse economic developments usually have stronger impacts on
CRE markets and financing compared to its relative, the residential real estate market. CRE
financing is clearly a global business that accounts for a considerable part of banks' assets.
As highlighted before, the CRE market attracts multiple lenders with different backgrounds.
And they have a multitude of finance tools in their hands. It is not surprising that CRE finance
is rather complex and differs even more among countries compared to the residential
equivalent. All this contributes to limited availability, quality and comparability of data on CRE
financing and markets. (slide)
This workshop aims at the importance of CRE underwriting and its role in financial stability.
There are numerous aspects and implications to discuss over the next few hours. And
hopefully, there are first conclusions being drawn and questions being answered. For
example: In what way may CRE cycles and potential asset price bubbles affect CRE
underwriting and financial stability? To what extent would the deterioration of CRE-related
asset quality and values affect banks' balance sheets? Does banks' forbearance play an
important role? What would be the effect of further loan losses and break away of profits,
which relate to CRE lending? What are the dynamics and dependencies between investors,
different types of lenders, market developments, and economic prospects? And last but not
least: From a regulator's perspective - and as a possible issue for discussion during the
afternoon sessions -, do we have all relevant information and tools at our discretion to
identify CRE related risks and to manage or even limit those to an acceptable level?
A stable financial system is essential. CRE underwriting plays an important role in this.
Appropriate information and instruments now need to be identified and if seen as necessary
should be implemented subsequently. This workshop and all your contributions will help to
take the right steps towards safer banks and a better financial system. As a central banker, I
am therefore particularly happy that my fellow lead discussants in this session all are from
the private sector. And I look forward to your contributions.
Thank you very much for your attention.