The commercial real estate market is pro-cyclical. This feature, together with the relative size of the industry and the large capital inflows, has made this sector relevant for financial stability. Using a novel loan level data set covering the commercial real estate portfolios of Dutch banks we aim to uncover potential drivers of distress in commercial real estate loans. Furthermore, we estimate the relative importance of idiosyncratic and systematic factors and emphasize the importance of bank behavior for distinguishing between good and bad credit growth. We find that loans originated near the peak of the cycle are riskier, confirming the pro-cyclical nature of the market. As opposed to loans originated during busts, the risk of boom loans does not decrease when economic conditions improve. Idiosyncratic factors correlated with higher credit risk are loan-to-value ratios and interest rates, especially when coupled with variable rate contracts. Moreover, we find that collateral type plays a role, as loans for non-residential (office, retail, industrial) real estate with higher vacancy rates are riskier. These results have implications for both macroprudential and microprudential supervision, as they demonstrate the pro-cyclicality of the market and show that indicators like loan-to-value, interest rate structure and vacancy rates must be monitored more carefully in boom times.
Keywords: macroprudential policy, risk monitoring, commercial real estate, procyclicality of credit.
Working paper no. 653