‘We’re not out of the woods’: How commercial property could spark a financial shock

• Transaction volumes and prices in commercial property sank in the second quarter of 2020, after the first coronavirus lockdowns were imposed.
• The sector has recovered somewhat since then — mainly in Asia, where restrictions have mostly been lifted for some time — but the sector remains under a lot of pressure.

LONDON — The International Monetary Fund has raised concerns over commercial property and the risk it could pose to financial stability, as the sector faces a series of challenges on the back of the coronavirus crisis.

These include the fact that many non-essential retailers were forced to shut their doors as economies across the world locked down in response to the pandemic. In addition, many employees began to mostly work from home, and online shopping surged. It has raised questions about the future of physical stores, whether companies will move to smaller offices, if retailers will need bigger logistic warehouses, and ultimately how all of this will impact rents.

"Going forward, I don't think we are out of the woods yet for a couple of reasons," Fabio Natalucci, deputy director of the monetary and capital markets department, told CNBC on Friday.

"One is that, historically, if you go back to the financial crisis there was a difference in time between how equity markets, for example, reacted … So, they dropped sharply, and they recovered in 2008, but the realization of losses in the commercial real estate took longer."

Transaction volumes and prices in commercial property sank in the second quarter of 2020, after the first coronavirus lockdowns were imposed. The sector has recovered somewhat since then — mainly in Asia, where restrictions have mostly been lifted for some time — but the sector remains under a lot of pressure. 

"There is a huge amount of uncertainties about the outlook, the economic outlook, so understanding what is conjectural here and what is going to be structural is going to be crucial," Natalucci added.

It remains to be seen how many businesses have been forced to close as a result of the pandemic, including shops, hotels and restaurants. But, ultimately, the sector's future could become an issue for financial stability.

"In a nutshell: the sector is relevant for financial stability mainly for three reasons. So, the first is because of its large size, secondly it heavily relies on the debt funding and, also is strongly interconnected with other sectors of the economy," Andrea Deghi, a financial sector expert at the IMF, told CNBC on Friday.

He explained that if a slew of businesses in the sector were to collapse, then that could add pressure on banks who have lent money to them. Banks could incur "very large capital losses," he said.

In addition, the commercial property sector also relies heavily on investment from outside of the banking sector.

"When the value of assets held by these investors fall, they might become less willing or able to provide new financing to commercial real estate borrowers, in particular when their balance sheets become weaker," Deghi added.

As such, the IMF said in a report Monday that policymakers should use targeted policy tools, including limits on debt-service ratios, to reduce the potential risks to financial stability. At the same time, non-bank institutions should also be covered by these tools given, how important their funding is to the sector.

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