Kai Hartmann Photography/BaFin
BaFin office in Frankfurt am Main
Germany’s real estate sector faces a persistent and escalating wave of non-performing loans (NPLs) as structural issues in commercial property financing continue to erode credit conditions. Unlike the short-lived impacts seen in previous cycles, today’s NPL surge stems from deeply rooted market shifts, with challenges exacerbated by regulatory constraints under frameworks like MaRisk.
The latest study from EY-Parthenon highlights a complex outlook in German real estate finance, particularly in the office sector, where excess supply, valuation difficulties, and regulatory constraints are tightening lending conditions. Legacy debts compound these issues, and banks, now more cautious than ever, increasingly require higher equity stakes from borrowers. Together, these factors magnify refinancing risks and intensify volatility across the market.
EY-Parthenon’s latest findings underline banks’ cautious stance on office property financing. Due to both excess office space and a stagnant transaction market, valuing these properties has become extremely difficult, leading to uncertainty and a heightened risk profile for office loans. Jean-Pierre Rudel of EY Real Estate describes banks’ approach as "restrictive," with lenders increasingly prioritising loan-to-value (LTV) ratios and debt service coverage ratios. Moody’s further supports this caution, citing that office loans originated pre-2022 now pose the highest risk across European commercial real estate loans.
Banks’ stringent risk management strategies, especially in the office sector, have in many cases led to significant delays in refinancing, with some lenders opting for short-term extensions rather than long-term solutions. "Banks are primarily focused on refinancing and cleaning up their loan books," says EY Real Estate’s Jean-Pierre Rudel. However, these short-term solutions often leave lenders in a precarious position, unable to underwrite new business due to equity capital tied up in legacy debts.
Regulatory constraints: MaRisk and its impact
Under the Minimum Requirements for Risk Management (MaRisk), German banks face strict oversight on distressed loans. MaRisk mandates that non-performing loans be placed under intensive supervision and limits banks’ flexibility in granting extensions. In practice, this means that if an NPL is extended, the bank must continue to provision for the full amount of the loan, adding pressure to the balance sheets. According to lawyer Phillip-Boie Harder from law firm Anchor in Düsseldorf, this regulation prevents banks from prolonging real estate loans beyond two years without triggering re-evaluation processes, which could officially classify these loans as distressed assets.
Legal professionals such as Vincenz von Braun, Managing Director at Anchor, observe that these regulatory limitations are forcing banks to ask for increased equity from borrowers—a demand that many struggling real estate companies are finding hard to meet. Furthermore, Esfandiar Khorrami from Berlin-based lawyers Bottermann Khorrami highlights the complexities facing borrowers with legacy corporate structures that often complicate the entry of external investors. This additional burden, he notes, only adds to the urgency for borrowers to secure sound legal and financial advice early in the process.
NPL volumes could reach as high as €100bn
Jan Düdden and Oliver Platt of Arcida Advisors project a substantial rise in NPL volumes, which could peak at €100 billion, including both senior and subordinated debts across commercial real estate. Their Frankfurt-based firm expects to double its workforce in anticipation of this influx. According to Platt, speaking to REFIRE at the recent Expo REAL in Munich, the wave of NPLs is not yet a “Nazaré giant wave,” but a steady flow of troubled assets IS continuing to reach the market.
A notable example cited in the financial press is the Trianon building in Frankfurt, a high-profile case that epitomises the complex challenges in the office sector. Formerly valued in excess of €390 million - and much more than that, some years ago, as REFIRE remembers - the Trianon is now estimated to be worth €250 million due to a lack of modernisation, leaving a significant financing gap. Such cases illustrate how outdated properties struggle to meet today’s energy standards, a crucial consideration as tenants increasingly demand ESG-compliant office spaces.
Despite some movement in the NPL market, investor-buyer negotiations often stall over price expectations. Anglo-Saxon investors, seeking IRRs of 15% or more, typically demand 30-40% discounts on distressed assets—discounts that banks are hesitant to accept. This divide underscores the complex dynamics between price expectations and the willingness of distressed asset investors to meet banks halfway.
Regulatory pressures from BaFin and the ECB
The European Central Bank (ECB) and Germany’s financial watchdog, BaFin, are both ramping up scrutiny on banks’ exposure to real estate loans. Recent ECB and BaFin audits are scrutinising banks’ compliance with capital requirements, particularly in the context of CRE lending, as well as broader risk management strategies.
The ECB's assessments aim to ensure that banks remain resilient in the face of rising NPLs, and, with BaFin pushing to expand the definition of NPLs, banks face mounting pressure to recognize more distressed assets, even potentially solvent loans that are at risk of future default. This redefinition could accelerate shifts in bank portfolios, forcing an earlier response to credit risks and adding further strain to regulatory compliance efforts.
The ongoing “Risks in Focus 2024” report from BaFin reinforces concerns that commercial real estate loans pose a systemic risk to banks with high exposure. As a result, the regulator is pressing lenders to bolster their capital cushions to manage the anticipated increase in NPLs and potential loan write-downs. Furthermore, BaFin’s potential redefinition of NPLs could widen the scope of distressed assets, capturing performing loans that may be at risk of default.
Across the German real estate market, there is a consensus on the urgent need for proactive borrower-lender collaboration, with banks preferring to avoid forced sales and instead favouring measures like standstill agreements. Despite challenges, there are opportunities: private equity and hedge funds are exploring entry points into the distressed debt market, particularly in the office sector, where loans face refinancing hurdles. As more equity-rich investors enter the market, solutions such as debt funds, joint ventures, and strategic restructurings are gaining traction, providing the flexibility that traditional mortgage banks may lack.
REFIRE: As distressed assets gain ground across Germany’s real estate landscape, the office sector remains particularly exposed. With demand for high-quality, energy-efficient office spaces rising and values of older properties falling, refinancing options are increasingly limited, raising the risk of accelerated asset disposals and restructuring. While retail may be nearing the bottom of its downturn, office real estate faces a prolonged period of adjustment as market players navigate ongoing economic and regulatory pressures. For investors and lenders alike, navigating this phase will demand swift, strategic decisions, as the sector stands at a critical threshold for recovery or further distress.
