Analysts at Swiss Re Institute have warned that pressure in the office sector and tighter lending standards are challenging US commercial real estate, contributing to the weaker economic growth outlook and financial sector vulnerability.
While the pressures are unlikely to pose systemic risks, the reinsurer does expect the correction to last several years, but says the impact on small banks will likely be greater than for long-term investors and insurers.
“The US commercial real estate sector faces material headwinds over the coming years,” noted Mahir Rasheed, Senior Economist, Group Risk Management at Swiss Re, alongside James Finucane, Senior Economist and Shin Yukawa, Investment Professional, Group Asset Management.
The analysts explained that small US banks originate 80% of CRE bank loans and, in addition to substantial mark-to-market losses on securities holdings and deposit uncertainty, distressed real estate assets have fed anxieties over overall financial stability.
Even before recent bank sector stresses, the US CRE market saw prices slump amid weakening demand while lending standards tightened rapidly.
“Looking forward, we see a multi-year downturn in the office space, driven by entrenched structural changes in the post-pandemic economy,” the analysts wrote. “This will pressure both small banks and insurers, but the challenges will likely be more pronounced for the former, and they are unlikely to pose systemic threats to financial stability.”
Insurers face less immediate pressure than small banks given a lack of deposit risk, a larger weight toward higher-quality CRE mortgages and securities, a lower overall CRE weight in investment portfolios, and positioning towards less-affected segments such as residential, Swiss Re notes.
In the US, Swiss Re highlights that only 36% of annuity liabilities can be withdrawn by policyholders without penalty, and P&C liabilities are run proof.
In statutory filings at 2022, life insurers held USD 668 billion of mortgage loans and P&C insurers just USD 28 billion, which is 13% and 1% of their respective investment portfolios, compared to 24% of US banks’ lending.
Adding direct real estate holdings brings the portfolio shares to 14% and 2%, and insurer investment exposure to office is estimated at 21%, 11 percentage points below the national share, and at 29% for the relatively strong multi-family segment.
“Insurance exposures are also well-diversified across property types and geographies,” the analysts noted. “This suggests a broad-based CRE downturn poses less solvency risk to most insurers than to banks.”
