Downward angle icon Downward angle icon. Capital Economics estimated that commercial real estate prices could fall another 10% this year. Gary Hirschhorn/Getty Images Big financial institutions are investing more in commercial real estate than meets the eye, a study says. In addition to lending to property owners, they also lend indirectly to REITs, and their investments are up about 40%. Wall Street is concerned that high interest rates will hurt commercial real estate.
Large financial institutions have greater exposure to commercial real estate debt than commonly thought, suggesting greater potential systemic risk, new research suggests.
The paper, titled “The Shadow Always Touches Your Feet: The Impact of Bank Credit Facilities on Non-Bank Financial Intermediaries,” notes that while most analysts focus only on banks' balance sheets, banks also provide credit to real estate investment trusts as a form of indirect lending to the commercial real estate sector.
Taking this into account, banks' exposure to commercial real estate debt increases by around 40%.
Concerns about systemic risk in commercial real estate have grown sharply in recent years as high interest rates and declining demand have raised doubts about the market's ability to repay debt.
Regional banks are the largest providers of these loans, raising concerns that a large-scale debt outflow could trigger a banking crisis.
These concerns should also apply to large Wall Street dealers when considering REITs' credit lines and long-term loans, the study authors wrote.
“During periods of aggregate stress, CRE REITs may draw down on their credit facilities in concentrated waves, and the collateral damage to large banks from such drawdowns suggests that the systemic risks arising from CRE exposures may be significantly greater than implied by banks' direct CRE exposures,” they wrote.
“The Shadow Always Touches Your Feet: The Impact of Bank Credit Facilities on Nonbank Financial Intermediaries.”
REITs are companies that buy and operate commercial real estate and sell shares to investors who want to invest in the space.
But these investment vehicles often rely on debt and are vulnerable to high interest rates. Even REITs backed by big Wall Street firms have had to contend with nervous investors over the past two years.
These investment vehicles are experiencing increasing redemption requests, putting REITs under pressure to obtain more credit from banks, the study noted. In fact, credit lines are growing at a much faster pace than other forms of borrowing, which could have a significant impact on lenders in the event of a crisis.
“Drawdowns on these commitments severely weaken banks if the market fails to provide a commensurate return or if banks charge appropriate credit facility fees,” the authors write.
They added: “We find that ignoring the unique characteristics of REITs as a borrower class could underestimate the capital needs of the U.S. banking system by as much as 37%.”