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Germany's banking sector is navigating stormy waters as more borrowers, particularly in the commercial real estate market, face mounting challenges in servicing their loans. After the sharp rise in interest rates since 2022, financing costs have surged, while property values continue to slide, leaving many unable to refinance their existing loans. This combination is pushing a growing number of loans into the non-performing category—a situation that is set to worsen as market conditions remain difficult.
The Bank for International Settlements (BIS) has issued a stark warning on the horizon. "Credit losses are still ahead of us," remarked Claudio Borio, Chief Economist at BIS, underscoring the delayed effects of rate hikes on the real estate market. The data backs up this concern. According to MSCI, capital values of German office properties—one of the most critical segments of commercial real estate—plummeted by 10.8% in 2023. This sharp decline exceeds the impact of the 2008 financial crisis, which saw a 3.5% drop. The fall has persisted into 2024, with VdP, the Association of Pfandbrief-issuing Banks, reporting a 9.9% decline in office property prices from January to March. “Further price drops are inevitable,” warned Jens Tolckmitt, head of VdP, as he highlighted the pressures facing the retail sector too.
BaFin, Germany’s financial supervisory authority, has been increasing oversight in response to these market stresses. BaFin’s "Risks in Focus 2024" report highlights how defaults on commercial real estate loans could pose a systemic risk, especially to banks that are heavily exposed to the real estate sector. BaFin's special audits under the German Banking Act are part of a broader effort to assess risk exposure and stave off instability in the banking sector.
Deloitte’s bleak forecast
A recent Deloitte survey of 100 bank executives paints a similarly grim picture. 78% of respondents expect an increase in non-performing real estate loans over the next 18 months, with 25% predicting a "strong or very strong" rise. "This is a bad omen for the banks themselves," cautioned Christoph Roessle, a Deloitte partner and co-author of the study. Given the significant share that real estate holds in German credit portfolios, the growing volume of non-performing loans could force many banks to shift strategy and restructure their loan books.
Backing up this view is Oliver Platt, Managing Partner at Arcida Advisors, who pointed out that non-performing commercial real estate loans surged by 129% in the first quarter of 2024 to €14.2 billion. Platt expects this figure to climb to €60 billion by the end of the year. He underscored the magnitude of the challenge, remarking that “for some market participants, the outlook is bleak.” However, he also noted that this NPL surge could present opportunities for private equity and hedge funds looking to enter the distressed loan market. While such opportunities exist, Platt stressed that many real estate companies are struggling, particularly those with long-term loans secured during the low-interest-rate era who now face refinancing at much higher rates.
The refinancing gap: a crisis in the making
The refinancing gap took centre stage during a recent panel discussion hosted by RUECKERCONSULT. Experts Professor Dr. Felix Schindler (HIH Invest), Francesco Fedele (BF.direkt AG), Ingo Glaeser (Münchener Hypothekenbank), and Torsten Hollstein (CR Investment Management) provided sobering insights into how both borrowers and lenders are grappling with a rapidly changing financial landscape.
Felix Schindler, Head of Research & Strategy at HIH Invest, explained the impact of falling loan-to-value (LTV) ratios and declining property values. Using a hypothetical example, he demonstrated how a property valued at €100 million in 2020 with a 65% LTV ratio could see its value drop to €80 million today. With banks now only accepting 55% LTV, that same borrower would be eligible for just a €44 million loan, leaving a €21 million shortfall that would need to be filled by fresh equity. "Equity is a limited resource,” Schindler emphasized, illustrating the additional strain this puts on borrowers. The knock-on effect? Diminishing returns on equity and a growing refinancing gap.
Francesco Fedele, CEO of BF.direkt AG, warned that early engagement with lenders is critical. He advised borrowers to approach financiers at least a year ahead of their loan maturities, given the more stringent credit checks in the current environment. Fedele also pointed out that banks are using the refinancing process to offload riskier loans. "If you're exposed to troubled asset classes, such as office properties, your chances of securing refinancing in that category are slim,” he said, stressing the need for borrowers to act preemptively to avoid being blindsided by changing credit conditions.
However, the role of debt funds became a point of contention. Ingo Glaeser, Head of Commercial Property Clients at Münchener Hypothekenbank, expressed skepticism over debt funds, arguing that their higher interest rates could limit their usefulness in a stressed market. "The higher rates debt funds demand don’t pay off in today’s tense economic situation,” Glaeser noted, casting doubt on their role as a long-term solution.
In contrast, Torsten Hollstein, Managing Director of CR Investment Management, sees debt funds as a critical part of the solution. "Debt funds are stepping in where mortgage banks can’t,” he explained, particularly in value-add properties or project developments where banks may be reluctant to take on risk. Hollstein believes debt funds can provide flexibility, particularly when they manage without amortization, which eases cash flow pressures for borrowers. "They offer breathing room," he noted, stressing that in certain cases, debt funds are replacing traditional mortgage banks entirely.
Where will fresh equity come from?
The key question facing the market, as highlighted by Schindler, is where fresh equity will come from. With a projected €20 billion refinancing gap between 2024 and 2028, office and retail properties are set to bear the brunt of the shortfall. Schindler pointed out that institutional and private equity funds are ready to invest, but the outflow of capital from Europe has complicated matters. "Unlike the financial crisis, there are equity-rich players ready to step in, but capital outflows are hampering their ability to replenish the necessary funds,” he remarked.
Despite this, the panelists noted that cooperation between borrowers and lenders has improved, with most banks looking to avoid forced sales or foreclosures. “All financiers are actively working to avoid realizations,” Hollstein observed, citing the increased use of standstill agreements as a way to give borrowers time to stabilize.
A cautious outlook
Though there is no expectation of a dramatic market collapse, the panelists agreed that the challenges are far from over. “I don’t expect any Hawaiian super waves,” joked Hollstein, “but we’ll certainly see North Sea waves from Sylt—small, fast, and insidious.” This metaphor summed up the mood of the panel—cautious, but not catastrophic. Francesco Fedele also braced for a prolonged period of stress, particularly in sectors like project development, where the wave of insolvencies has yet to peak.
For borrowers in trouble, the advice from the panelists was unanimous: act early, engage with lenders, and explore alternative financing options. Debt funds, joint ventures with private equity, and fresh equity injections may offer paths forward, but timing will be critical. The refinancing gap is large, and while equity-rich investors may be ready to step in, they won’t wait forever.
REFIRE: With Schindler, Fedele, Glaeser, and Hollstein offering distinct but aligned perspectives, the message is clear: the German real estate market faces a long, uphill battle. Non-performing loans will continue to rise, and the refinancing gap looms large. Early action, creative financing, and proactive borrower-lender collaboration will be key to navigating these challenging times. As always, the clock is ticking.
