Banks Are More Exposed to Commercial Real Estate Debt Than It Seems

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.

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%.”