The International Monetary Fund (IMF) issued a report warning of the risks associated with commercial real estate assets in light of the global COVID-19 pandemic. In particular, the report identified three areas of risk to the global economy emanating from distressed commercial properties.
- Decline in Demand for CRE: Precautionary measures related to COVID-19 have created a negative shift in demand for hotels, offices and retail shops, which impacts jobs, investment and overall economic activity.
- Risks to the Global Financial System: Ownership of commercial real estate relies heavily on lending by various financial institutions. The stability of major financial institutions maybe undermined if owners of distressed commercial properties default on their loans, thereby threatening the foundation and soundness of the global financial system.
- Decline in Asset Value: Commercial property constitutes a significant component of the assets held by various financial and non-financial institutions such as banks, insurance companies, pension funds and investments funds, among others. Therefore, a significant drop in real estate prices may hurt investments by multiple institutions and contribute to an overall slowdown in economic activity. The report states that ” a 50-basis-point drop in the capitalization rate from its historical trend—a commonly used measure of misalignment—could raise downside risks to GDP growth by 1.4 percentage points in the short term (cumulatively over 4 quarters) and 2.5 percentage points in the medium term (cumulatively over 12 quarters).”
The IMF goes on to recommend limits on debt service ratios by banking on non-banking institutions as well as stress testing exercises to ensure that “adequate capital has been set aside to cover commercial real estate exposures.”