Banks are more exposed to commercial real estate than regulators realize 

Bank exposure to commercial real estate has been under the microscope for more than a year, but researchers are positing that the full picture of possible distress remains obscured.

The credit lines and loan terms that banks provide to real estate investment trusts are leading big institutions to be more exposed to commercial real estate than regulators may realize, according to Bloomberg. 

That conclusion comes courtesy of a recent study led by New York University economics professor Viral Acharya and Frankfurt School of Finance & Management assistant professor Max Jager, among others. The researchers found that big banks’ exposure to commercial real estate lending grows by 40% when indirect REIT lending is considered. That type of exposure isn’t being scrutinized as much as loans on bank balance sheets, Acharya said.

REITs tend to be relatively cash poor, as they are required to pay large dividends annually. That could lead them to draw on credit lines when redemption requests are high, something that Starwood REIT is now experiencing as it is burning through liquidity.

“Collateral damage to the largest banks from intensive credit line draw-downs means that systemic risk from total CRE exposure is probably much greater than if you only look at direct exposure,” said Manasa Gopal, one of the co-authors.

One of the study’s takeaways is that regulators need to improve the incorporation of a lender’s exposure to real estate investment trusts when conducting stress tests.

Just how big that threat is to large institutions is unclear. Morgan Stanley has the highest share of its own credit lines committed to REITs among the five biggest banks by market capitalization. But a financial stability report from the Federal Reserve last month found bank credit commitments to REITs dropped from the previous year.

At the end of the first quarter, office market distress in the United States — a particularly troublesome sector in commercial real estate — stood at $38 billion, according to MSCI Real Assets. Large banks held $345 billion of indirect exposure to commercial real estate at the end of the fourth quarter of 2022, more than tripling the total from the last quarter of 2013.

— Holden Walter-Warner

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