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Thought leadership: CRE as a proxy for financial stability

In late March 2021, the International Monetary Fund (IMF) published a blog about the “crossroads” that real estate currently finds itself, and warning that this has implications for the wider economies and economic stability. It is a fascinating read and one that really drives home the centrality of the commercial real estate (CRE) sector.

“Empty office buildings. Reduced store hours. Unbelievably low hotel room rates. All are signs of the times. The containment measures put in place last year in response to the pandemic shuttered businesses and offices, and dealt a severe blow to the demand for commercial real estate—especially, in the retail, hotel, and office segments.”

– Andrea Deghi and Fabio Natalucci, writing for the IMF

A proxy for financial stability

The case the blog authors make is that the CRE sector is significant enough, with value and volume enough, that price movements observed within “tend to reflect the broader macro-financial picture”, and warning that the reliance on debt funding makes CRE and the broader economy vulnerable to volatility – and unforeseen shocks, like the Covid-19 pandemic.

This is because of the linkages between global bank’s lending portfolios and CRE. Globally, banks are the largest providers of debt funding for the CRE sector, although in recent years some non-bank financial institutions (the blog gives the example of insurance firms, pension, and investment funds) have seen the value in the asset type too.

The authors fear that shocks or price misalignments in CRE therefore have the potential to cause ripple effects in financial services and banking, as well as broader GDP and GDP growth – underpinning what so many of us in CRE have said for decades: “It is a pivotal and influential sector”.  

Underlying value

This may cause alarm for some – those who remember the crashes and crunches of the sub-prime crises – but it is absolutely critical to emphasize that this is not about over-leveraging. The IMF blog states specifically: “Unlike previous episodes, however, this time around the misalignment does not stem from excessive leverage buildup but rather from a sharp drop in … revenues and … demand”, a change driven by the global pandemic response.

So this blog doesn’t ring a panic button – good news for analysts and CRE professionals. It does however speak to the way that society is changing, and calls for the sector to be cognizant of this and evolve accordingly. This is very much our strategy at NAI Global – we are market-linked, market-informed, and market leaders.

What next?

We are in agreement with the blog authors who say that any misalignments are “likely to diminish” as the economy recovers. This is thus an opportunity to prepare ourselves for the structural changes necessary to keep the sector vital and responsive to trends like working from home and other shifts. An example of the latter is how 2020 heralded an uptick in movement from customer-facing retail to multichannel shopping and e-commerce, which underpins the growth in warehousing. 

So now what?

With apologies to Spiderman, the phrase that immediately springs to mind is: “With great power comes great responsibility”. CRE professionals and institutional funders will need to make smart choices to promote recovery of this essential sector without introducing more risk – responsible lending, innovative funding models, and socio-economic trend-aware strategies.

Social: What CRE trends are you watching in your area? And what are the new demands of tenants and developers as we head towards ‘the new normal’?

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