FSB report identifies vulnerabilities in non-bank CRE investors

The Financial Stability Board (FSB) has published a report, alongside a press release and updated webpage, examining vulnerabilities in non-bank commercial real estate (CRE) investors. The report identifies entities such as real estate investment trusts (REITs) and property funds as being particularly exposed to the risks of higher interest rates and highlights three key vulnerabilities in these types of investors.

Firstly, some open-ended property funds face liquidity mismatches, while offering frequent redemptions (daily/monthly) for their shares, making them susceptible to investor runs. The FSB notes that implementing its recommendations could help address this issue. Secondly, some REITs and property funds carry high financial leverage, which increases the sensitivity to falling property values. This can trigger breaches of loan covenants or credit rating thresholds, potentially leading to forced deleveraging. Investor concerns over leverage may also prompt fund outflows or REIT share sell-offs, further exposing liquidity mismatches. Thirdly, due to market illiquidity, asset pricing is particularly difficult during times of stress. Infrequent valuations and loan modification practices can delay loss recognition, resulting in abrupt losses during downturns. The report highlights that improving transparency and ensuring investors account for valuation uncertainty in their risk management frameworks could help mitigate this vulnerability. A potential fourth broader vulnerability of complex interlinkages between banks and non-bank CRE investors, is also identified. However, a full assessment is limited by data gaps. The FSB states that closing these gaps would enhance authorities' ability to monitor and manage risks effectively. Finally, the FSB states that ongoing monitoring of the CRE market is necessary.

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