Washington, Frankfort Real estate banks are preparing for more difficult times in the American commercial real estate market. Above all, Deutsche Bank, which played a central role there until the pandemic, warns: “If interest rates remain high as expected, this could lead to difficulties on the US real estate markets,” said US boss Christiana Riley in an interview with the Handelsblatt. “While we have a conservative portfolio, rising interest rates will impact commercial property coverage ratios and valuations. We are closely monitoring the situation and our portfolio.”
The German financial institutions Aareal Bank and Deutsche Pfandbriefbank (PBB), which specialize in financing commercial real estate, made similar statements. PBB boss Andreas Arndt said when the quarterly figures were presented on Monday: “We have become a bit more cautious when it comes to the selection of properties, property types and property risks.”
For example, his institute originally considered entering into riskier transactions, so-called mezzanine financing, in the USA. This refers to subordinated loans that, in the event of bankruptcy, are only serviced after the first-ranking creditors from the insolvency estate. “We put that back. That’s a risk class in which we don’t want to be on the road at the moment,” warned Arndt. Such a deal should be done when the market moves up again. In his view, that is not the case at the moment.
European banking supervisors have been watching the activities of European banks in this area with eagle eyes for a long time. “The risks are clearly increasing, especially in the commercial real estate market and especially among real estate developers, who are particularly sensitive to interest rate increases,” said Bafin President Mark Branson at an industry conference on Monday.
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Many bank supervisors consider these transactions riskier than some banks do.
Further rate hikes are likely
The framework conditions for commercial real estate are difficult: The key interest rate in the USA is currently in the range of 3.75 to four percent and is therefore the highest it has been in 14 years.
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Although inflation was 7.7 percent lower in October than in the previous month, it was well above the target value of two percent at which the US Federal Reserve (Fed) sees price stability. Interest rates could therefore rise further.
This development is paired with the trend towards working from home, which continues long after the lockdowns. It is true that an increasing proportion of employees have returned to the offices in recent months. But many cities are still a long way from the levels before the pandemic. In New York, for example, 48 percent of employees are back at work, according to mid-October data from security firm Kastle Systems.
Even big banks like JP Morgan Chase and Goldman Sachs and tech companies like Facebook have had to make concessions to their employees, despite originally demanding that all employees return to the office towers as soon as possible.
“Deutsche Bank has played a major role in shaping the skylines of America.”
(Photo: Bloomberg)
According to US boss Riley, Deutsche Bank expects structural shifts. “This applies above all to dealing with the return to the offices.” She assumes that many employers will only decide in the next two to three years whether to renew the leases for their office buildings.
The institute therefore does not want to take any unnecessary risks. “We have been very careful about the projects we are willing to fund for quite some time. And we look at office properties in certain cities with greater skepticism,” Riley clarified. According to industry experts, demand has collapsed in New York and Washington DC in particular.
Aareal Bank nevertheless sees potential in the USA
Despite these trends, Wiesbaden-based Aareal Bank remains optimistic about the US commercial real estate market. “Of course, some office buildings will look different in five years than they do today. However, there will continue to be demand for it, especially for buildings in very good locations,” said Aareal Bank CEO Jochen Klösges in a conference call last week. “That means we are concentrating even more on offices in very good locations than in the past.”
The bank, which specializes in financing commercial real estate, concludes large parts of its lending business abroad, and the US market is of great importance to the institute. Aareal Bank does around a third of its business in North America.
Klösges estimates the portfolio of office financing at 4.3 billion euros. “That’s about half of our portfolio in the US,” he said.
Under no circumstances does Klösges want to do without the North American business. North America reacts more elastically and faster than Europe to economic events, “both in the upswing and in the downswing”.
It thus contributes to diversifying Aareal Bank’s risks. “We’ve seen a very strong rebound in the hotel segment this year, for example,” he added. In addition, Aareal Bank does not finance new buildings, only completed buildings, occasionally those in need of renovation. According to Klösges, there will continue to be opportunities on the US market to provide good financing.
Mortgage bank is growing in the US
PBB boss Arndt formulated it similarly. Business in the USA is growing and will play an important role in growth prospects over the next three years. “At least in the western hemisphere, the US market is still the world’s largest, most transparent and transaction-friendly market, with a high level of liquidity and with very professional and practice-oriented participants,” says Arndt. PBB feels very comfortable there with its business approach.
Deutsche Bank recently played a key role in financing the construction of the new Hudson Yards district in Manhattan.
(Photo: IMAGO/UPI Photo)
The Pfandbriefbank only entered the US market a few years ago. In the first nine months of this year, the USA accounted for 19 percent of new business. At around 17 percent, the share in the loan portfolio is now almost as high. In 2016, the US share in PBB’s financing portfolio was still zero.
Real estate financing is actually an important business driver for Deutsche Bank too. The Frankfurt Institute is one of the leading providers in New York when it comes to large and complex financing of commercial real estate. Since 2014, the bank has supported US commercial real estate clients with nearly $110 billion in financing, it announced two years ago. More recent figures have not been published.
Most recently, the institute played a key role in financing the construction of the new Hudson Yards district in Manhattan. Hudson Yards is the largest private real estate development in US history. It was largely driven by Related and Oxford Properties, which are among the largest real estate companies in the world.
“Deutsche Bank has played a major role in shaping the skyline of America. It’s an important part of our business in the US,” said Riley, who is also celebrating the bank’s 150th anniversary in America this year.
Like many Wall Street houses, the Frankfurt institute is currently trying to find a balance. On the one hand, the banks want to be there for their customers even in difficult times. On the other hand, they don’t want to take unnecessary risks.
The Credit Suisse case has shown how drastic investors can react when there are doubts about the stability of a bank. Deutsche Bank has therefore become more cautious in granting so-called leveraged loans, loans to highly indebted companies, as well as in lending in general. “We are happy about our good capital resources. Because it allows us to accompany our customers wherever the risks are appropriate,” says Riley. And: “We are becoming increasingly choosy when it comes to where we invest our capital.”
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