Global property market faces $175 billion debt spiral

(Bloomberg)—The slump in the world’s biggest asset class has spread from the housing market to commercial real estate, threatening to unleash waves of credit turmoil across the economy.

Almost $175 billion of real estate credit is already distressed, according to data compiled by Bloomberg — about four times more than the next biggest industry. As the toll from higher interest rates and the end of easy money mounts, many real estate markets are almost frozen with some lenders telling borrowers to sell assets or risk foreclosure amid demands for additional capital from landlords.

The slump has been visible in downtown Chicago over the last several years. Soaring construction costs, property taxes and interest rates have all had a huge impact. So, too, has a record amount of available office space. 

Retail landlords are just as anxious to see more office workers coming downtown regularly again. Loop storefront vacancies stood at a 20-year high during much of 2022, as the absence of daily foot traffic compounded the effects of online shopping on brick-and-mortar retailing.

Weak demand and a surge of sublease offerings from companies trying to shed unneeded workspace are forcing landlords to shell out huge amounts of cash and other perks to get deals done, while pushing some to surrender their properties to their lenders rather than face foreclosure battles.

Distress levels in European real estate are at the highest in a decade, in part because of a decline in liquidity, according to a study by law firm Weil, Gotshal & Manges. UK commercial property values fell more than 20% in the second half of 2022, MSCI Inc. data show. In the US, the drop was about 9%, according to Green Street.

The fall in transactions and development in commercial and residential real estate will inevitably impact spending in the real economy. In turn, that could pose a risk to jobs and growth.

“What we have in this downturn is a fairly unique set of economic circumstances. Interest rates are tightening instead of softening the blow for real estate and other corporates,” said Ian Guthrie, a senior managing director at the loan advisory team at Jones Lang LaSalle Inc., a real estate broker. “You have a pipeline of potentially defaulting loans” where “values are under pressure and cash flows are under pressure.”

This year, he added, “is when those problems will start to manifest themselves.” About one in 10 corporate loans in Europe is already underperforming and showing increased credit risk, according to JLL.

The abrupt halt to more than a decade of easy money has been made worse for property companies by a pandemic that has changed the way people work and live, leaving many commercial real estate owners high and dry.

The repercussions are being felt across the world. A Brookfield real estate unit warned in November that it may struggle to refinance debt on two downtown Los Angeles towers and raised the prospect of foreclosures, which Barclays Plc analysts called “concerning” for the market. A missed debt payment by the developer of the Legoland Korea theme park triggered a credit crunch in the country, with the central bank forced to act to stabilize markets. Australia’s Caydon Property Group Ltd. blamed Covid lockdowns and rising interest rates when it fell into receivership.

“We expect to see some casualties” among UK developers, said Nicole Lux, who studies real estate credit at Bayes Business School. “There will be fire sales.”

Commercial property — from offices to shopping malls — is more sensitive to economic conditions than other asset classes, said Andreas Dombret, who served on the boards of Germany’s Bundesbank and the Bank for International Settlements, adding that “in the past, when the bubble did burst, very often this was related to commercial real estate.”