commercial property overvaluation could create new shocks

Oxford Street is empty of shoppers as national coronavirus lockdowns continue.

Mike Kemp | In pictures | Getty Images

LONDON – The International Monetary Fund has raised concerns about commercial real estate and the risk to financial stability as the sector faces a number of challenges due to the coronavirus crisis.

That includes the fact that many non-essential retailers have been forced to close their doors as economies around the world have closed in response to the pandemic. In addition, many employees started working mainly from home and online shopping increased. Questions have been raised about the future of physical stores, whether businesses will be moving to smaller offices, whether retailers will need larger logistics warehouses, and how all of this will ultimately affect rents.

“I think we’re not out of the woods for several reasons,” Fabio Natalucci, deputy director of the money and capital markets department, told CNBC on Friday.

“One of them is that historically, when you go back to the financial crisis, there was a time difference in how the stock markets reacted, for example … So they fell hard and bounced back in 2008, but it took longer to realize losses in commercial real estate.”

Transaction volumes and commercial property prices fell in the second quarter of 2020 after the first coronavirus lockdowns were imposed. The sector has recovered somewhat since then – mainly in Asia, where restrictions have largely been lifted for some time – but the sector remains under great pressure.

“There is a lot of uncertainty about the outlook and the economic outlook, so understanding what is presumed here and what will be structural is critical,” added Natalucci.

It remains to be seen how many businesses have had to close as a result of the pandemic, including shops, hotels and restaurants. Ultimately, however, the future of the sector could turn into a problem for financial stability.

“In short, the sector is relevant to financial stability for three main reasons. On the one hand, it is due to its size and, on the other, it is heavily dependent on debt financing and also strongly linked to other economic sectors.” Andrea Deghi, a financial sector expert at the IMF, told CNBC on Friday.

He said that if a number of companies in the sector collapsed, it could put pressure on banks that have lent them money. Banks could suffer “huge capital losses,” he said.

In addition, the commercial real estate sector is heavily reliant on investment from outside the banking sector.

“If the value of the assets held by these investors declines, they may be less willing or able to provide new funding to commercial home borrowers, especially if their balance sheets weaken,” added Deghi.

As a result, the IMF said in a report on Monday that policymakers should be targeted policy tools, including caps on debt service ratios, to reduce potential risks to financial stability. At the same time, non-banks should also be caught up in these instruments when it comes to the importance of their funding to the sector.