Banks Have an Invisible Extra Exposure to CRE

Banks have faced scrutiny from regulators, markets, and even their depositors, because of their exposure to commercial real estate lending. As transactions and valuations have fallen and many owners cannot refinance their properties, the status of CRE loans has been under increasing pressure. Many banks have pulled away from commercial real estate lending.

A new paper from researchers at the NYU Stern School of Business; Georgia Institute of Technology – Scheller College of Business; and Frankfurt School of Finance, CEPR now argues that banks face additional risk. Extensions of credit lines to nonbank financial intermediaries (NBFIs), with REITs being a prime example, provide the potential for extensive backchannel exposure. Additionally, they say that this less obvious relationship means larger banks face more risk from CRE than is generally assumed.

Interactions between CRE and banks have both the direct consequences previously mentioned and others that follow. “Considering the vast scale of the CRE market, valued at approximately $21 trillion in 20212, which is funded in part through bank loans, disruptions in the CRE sector can directly influence the availability of bank credit to households and businesses,” the authors wrote.

The researchers noted that the “exposure of regional and community banks is approximately 4 and 5 times greater, respectively, than that of large banks.” But the direct view is misleading.

“Once the indirect exposure of banks via credit lines is accounted for, CRE exposures are concentrated not only in the portfolios of smaller banks but also among the largest U.S. banks,” they wrote. “In particular, as credit lines can be drawn intensively by CRE REITs in times of aggregate stress, collateral damage to the largest banks from such drawdowns implies that systemic risk arising from CRE exposures is likely to be considerably greater than implied by direct CRE exposure of banks.”

There have already been examples, as previous GlobeSt.com coverage has shown. Starwood Real Estate Investment Trust, which started seeing a big wave of redemption requests in late 2022, has drawn more than $1.3 billion of its $1.55 billion unsecured credit facility since the beginning of 2023 following heavy redemption requests. Before 2023, the REIT hadn’t tapped its credit line. At the current rate, it will run out of credit and cash in the second half of this year unless it borrows more or sells more property assets, the FT says. In 2023, investors withdrew $2.6 billion from Starwood and $12.4 billion from Blackstone’s BREIT.

They concluded that “a big portion of large banks’ CRE exposure is through the provision of credit lines to REITs. Ignoring these exposures could lead to an underestimation of the risks in banks’ portfolios, especially under stress.”