Since the end of 2022, the situation on real estate markets has fundamentally changed. For many years, prices and valuations were on an upward trajectory. The real estate portfolios at many credit institutions have grown. Now prices are falling, loan granting has come to a standstill and the value of loan collateral has come under pressure. Generally speaking, reductions in overvaluations have a positive impact on financial stability. But to begin with, this development can greatly burden the earnings situation of credit institutions. In some cases, credit defaults can even jeopardise the existence of institutions if these institutions are not sufficiently diversified and are invested in especially critical segments.

Commercial real estate

Marked decline in prices, collapse in new business

Since mid-2022, prices for commercial real estate have been falling on a broad scale (see Figure 1). According to data from the Association of German Pfandbrief Banks (Verband deutscher Pfandbriefbanken e.V. – vdp), prices for office real estate declined in the third quarter of 2023 by 10.6 percent compared with the same quarter of the prior year, those for commercial residential real estate by 6.8 percent. Prices for retail real estate, which have been in decline for some time now, are continuing to fall due to the ongoing trend towards online trading. Since the end of 2019, value corrections in the retail real estate segment already amount to a total of 20 percent on average.

Figure 1: Prices for commercial real estate in Germany by segment

Source: BaFin, based on vdp data

Supply and demand have come under tangible pressure due in particular to unfavourable financing conditions, the economic downturn and high inflation that has especially affected construction costs, alongside changes in consumer behaviour and the trend towards online shopping or greater use of the possibility to work from home. The transaction volume in the commercial real estate area has fallen sharply: in the third quarter of 2023, it stood approximately 60 percent below the long-term average according to data from Jones Lang LaSalle.

After years of dynamic lending growth, new lending (excluding loans for commercial residential real estate) also fell sharply in the winter half-year of 2022/23 according to vdp data. Since then it has bounced back somewhat, albeit to a lower level, but remains clearly behind the volumes of previous years. In the near future, the development of loan commitments is likely to remain subdued given the marked downturn on the commercial real estate market.

Deterioration in credit quality

The risks in the commercial real estate market are likely to become apparent in the years ahead in the form of a deterioration in credit quality and, ultimately, by way of credit defaults. Until the end of 2022, NPL¹ ratio as lagging indicator remained unexceptional and comparatively stable over a long period of time, at approximately 2 percent. However, by the third quarter of 2023 it had risen visibly, especially among the SIs (see Figure 2). At the same time, a gradual downward adjustment of the value of collateral in credit portfolios is likely. This is because the present value of future rental income will be lower in response to the sharp rise in interest rates, which in turn will necessitate a downward adjustment of real estate values in many cases. Survey results indicate that German institutions are tightening their standards according to which new loans are granted.

Figure 2: NPL volumes and NPL ratio of commercial real estate loan portfolios of German SIs/LSIs

Source: Joint calculations of BaFin and the Bundesbank based on the supervisory reporting system, as at 30 September 2023

Here: Commercial real estate loans = Loans to non-financial corporations collateralised with commercial real estate

Banks with a focus on commercial real estate financing and project developers are subject to heightened risk due to their specific business models. Some banks concentrate their activities very strongly on domestic and international commercial real estate financing and are thus also exposed to upheavals in other countries. Due to their specialisation on commercial real estate financing, they show – like a number of other institutions – a cluster risk because they are unable to compensate losses in this segment through other business areas. Project developers, on the other hand, have no regular rental income in the planning phase and are therefore more vulnerable than holders of existing properties with solvent tenant structures. The marked increase in financing and construction costs is currently impacting project developers to a particularly strong degree. In 2023, several project developers had to file for insolvency.

The difficult conditions underlying the commercial real estate market can be expected to lower the earnings of the banks concerned for a longer period and necessitate higher risk provisioning. Strongly specialised business models or a bad choice of properties by banks could even cause problems for some banks.

Insurance undertakings

Insurers are also affected by the aforementioned developments because, as institutional investors, they are traditionally invested in residential and commercial real estate and grant mortgage loans. Commercial real estate accounted for approximately 8 percent² of insurers’ investments as at 30 September 2023. Insurers currently still have very high valuation reserves in their real estate portfolios. BaFin therefore assesses the risk from valuation changes as manageable on the whole.

Real estate funds

German asset management companies (Kapitalverwaltungsgesellschaften) account for a large share of the European market for open-ended real estate funds. The most important risk to which these funds are exposed from a supervisory perspective is liquidity risk. This risk arises if companies do not have sufficient liquidity in a scenario in which a very large number of investors wish to redeem their fund units. Were this to happen, the companies might have to suspend redemption. However, this has only happened in a small number of cases so far. As regards open-ended retail funds domiciled in Germany, this risk is reduced because of the two-year minimum holding periods usually applicable here alongside the one-year termination periods and fixed redemption dates.

There are no signs at the moment of a termination wave. As regards retail funds, slight net outflows have been noted since September 2023, while no such outflows have been recorded for special funds to date.

Residential real estate

Falling prices and weaker new business

On the German residential real estate market, prices for owner occupied properties declined in the third quarter of 2023 compared with the same quarter of the prior year period by 5.8 percent on a nationwide average according to vdp data. The drop in prices for existing properties is more pronounced than for new properties. Demand is falling as supply heads upwards slightly. This is the reason for the decline in prices.

The volume of residential financing of private households is growing, but at a far slower pace now. According to data from the Deutsche Bundesbank, the volume in the third quarter of 2023 was only 1.8 percent higher than in the previous year. Including commercial real estate construction, the total volume of residential mortgage loans amounts to approximately 1.8 trillion euros.

Far fewer new loans are being granted. From January to September 2023, new lending was 43 percent lower than in the prior year period (see Figure 3). The main reasons for this besides the drop in real incomes due to inflation are the significantly higher mortgage rates and construction costs. Residential real estate is becoming less affordable, demand is declining noticeably and potential buyers are increasingly turning to the rental market.

Economically, the turnaround on the residential real estate market can cause problems for credit institutions in the longer term. The increase in interest revenues from new business and from follow-up financing agreements is being additionally limited by lower new lending.

Figure 3: Dynamics in domestic banks’ loans for house purchase*

Source: Bundesbank calculations, as at September 2023

* Data adjusted for statistical changes.

There is another factor to bear in mind: institutions, the earnings of which stem for the most part from real estate loans with long-term interest rate fixations, have been profiting to a lesser degree so far from the increased interest rates than their competitors. As a rule, private housing loans in Germany have long interest rate fixation periods. However, as a result of the interest rate increases of past quarters, the share of very long-term loans of more than ten years has fallen somewhat and the share of loans with shorter terms has risen slightly (see Figure 4).

Figure 4: Fixed interest periods for loans to households in Germany for house purchase*

Source: Bundesbank calculations based on the MFI interest rate statistics, as at September 2023

*Calculated as domestic banks‘ volume of new business with respective rate fixation periods as a share of total new business (also including extensions).

No excessive credit defaults so far, collateral under pressure

In these conditions, credit institutions tightened their new loan granting standards in 2023, as shown by the Deutsche Bundesbank in its Bank Lending Survey for Germany (most recently in October 2023). The years ahead will see a growing number of expiring mortgage loans that had been concluded when interest rates were very low. This can cause problems in the case of follow-up financing agreements – particularly if borrowers are no longer able to afford the higher burden of lending costs.

All in all, lenders’ losses in the area of residential real estate are still moderate. Institutions’ provisioning ratio stood at 1.25% in the third quarter of 2023 – and thus on average compared with previous quarters. Due to inflation, loan defaults could rise slightly, especially if borrowers taking out follow-up financing agreements are unable to afford the higher interest and redemption payments. Considerable burdens are likely to occur if unemployment were to rise sharply amid a slump in economic activity.

A drop in real estate prices could mean that banks are only able to realise collateral at values below that of the outstanding loan amount. But as credit institutions mostly base their collateral valuations on the mortgage lending value rather than on the more volatile market value, they should have reserves to draw on in this area. Furthermore, the value of collateral furnished for older residential property is being lowered as demands on energy efficiency increase. The fall in prices in this market segment is especially pronounced.

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Risks in BaFin's Focus 2024
Foreword by the President

Main Risks in BaFin’s Focus

1. Risks arising from significant increases in interest rates
3. Risks arising from significant corrections on the international financial markets
4. Risks arising from defaults on loans to German companies
5. Risks arising from cyberattacks with serious consequences
6. Risks arising from inadequate money laundering prevention
7. Risks arising from market concentration due to the outsourcing of IT services

Trends

1. Digitalisation
2. Sustainability
3. Geopolitical turmoil

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