The commercial real estate market is currently experiencing the most significant downturn since the 2008-9 financial crisis, with higher borrowing costs and increased vacancy rates attributed to remote work. This article delves into the vulnerability of U.S. lenders as office prices plunge and compares the exposure of U.S. and European banks to commercial real estate (CRE) markets.

Major European banks have been cutting their lending to commercial property and have half the exposure of their U.S. peers. This reduced lending has resulted in a lower exposure compared to U.S. lenders, with about 70% of large-cap European banks reducing their exposure since 2022 to around 5% of their loan books, and nearly all lenders having sub-1% exposure to the United States.

In contrast, U.S. banks have about 11% exposure to commercial real estate, with mid-cap lenders having around 30% exposure. The vulnerability of U.S. lenders is further highlighted by the fact that $660 billion of commercial real estate debt is set to mature in the United States in 2024, against $150-$200 billion in Europe.

Refinancing risks and vacancy rates have been identified as key concerns for the market globally. Office vacancy rates are notably different between the two regions, with rates at 21% in the United States versus 8% in Europe. City-specific figures also vary widely, with San Francisco and Los Angeles experiencing vacancy rates of 32% and 27%, respectively, while London and Zurich have much lower rates at 9% and 5%, respectively.

According to analysts, in a 'stress scenario', in which property price falls force banks to recognize losses and borrowers' credit quality worsens, European banks would face a 3% hit to earnings over three years, which they called "manageable." This is significant considering that German regional banks have more than 20% CRE exposure, with such loans accounting for most of the loan books of specialist lenders Deutsche Pfandbriefbank and Aareal.

"Overall, we think CRE-related issues will not translate into a systemic event, but rather a manageable earnings impact localized to a small set of banks," stated Morgan Stanley analysts.

The commercial real estate market's challenges are complex, with global implications for both European and U.S. banks. Understanding these vulnerabilities is crucial for investors and financial institutions as they navigate this challenging landscape.

European Banks' Exposure and Earnings Impact

European banks have significantly reduced their exposure to commercial property, resulting in about half the exposure of their U.S. peers. Most large-cap European banks have decreased their exposure to commercial real estate since 2022 to around 5% of their loan books, with sub-1% exposure to the United States.

This reduction in lending has been prompted by potential risks associated with the current state of the commercial real estate market, including higher borrowing costs and increased vacancy rates due to remote work. In a 'stress scenario', European banks would face a 3% hit to earnings over three years due to property price falls.

It's important to note that German regional banks have over 20% commercial real estate exposure, with specialist lenders Deutsche Pfandbriefbank and Aareal having most of their loan books consisting of such loans. Additionally, Deutsche Bank has the largest commercial real estate exposure to the U.S. market among large European lenders, accounting for 1.5% of its loans.

The differences between large-cap European banks' approach towards commercial real estate become evident when compared to mid-cap lenders who possess around 30% exposure.

The overall outlook indicates that while there are significant challenges ahead for European banks due to their level of exposure, it's likely that any related issues will not lead to a systemic event but rather represent a manageable earnings impact localized primarily within specific banks.

Vulnerability of U.S. Lenders

U.S. lenders are facing heightened vulnerability as they navigate through the challenges posed by the current state of the commercial real estate market. With about 11% exposure to commercial real estate compared to their European counterparts who have roughly half that level of exposure at around 5%, U.S. lenders find themselves more exposed in this sector.

Furthermore, it's noteworthy that approximately $660 billion worth of commercial real estate debt is set to mature in the United States in 2024 compared to $150-$200 billion in Europe. These figures highlight the scale at which U.S. lenders are exposed in terms of refinancing risks and managing maturing debt within this sector.

Moreover, city-specific data on office vacancy rates also paints a picture of varying degrees between regions - from San Francisco and Los Angeles experiencing high vacancy rates at 32% and 27%, respectively; London and Zurich present much lower rates at just 9% and 5%, respectively.

These factors combined underscore how vulnerable U.S. lenders are amidst these challenging market conditions; therefore, it becomes imperative for them to adopt robust risk management strategies while navigating through this period marked by higher borrowing costs and increased vacancy rates due largely to remote work trends.