Hidden Risks in Commercial and Office Buildings... A 20% Drop Could Burden Financial Sector with 2.6 Trillion Won

Higher Default Risk Than Mortgage Loans
Repayment Risk Increases with Income Decline Due to Economic Downturn

[Asia Economy Reporter Jang Sehee] Commercial real estate, which is sensitive to economic fluctuations, is also considered a potential risk. Commercial real estate-backed loans have a lower recovery amount compared to mortgage loans, making them more vulnerable to defaults. Due to the COVID-19 pandemic, self-employed business owners have collapsed, causing a sharp decline in commercial property income, and if commercial property prices also fall, the loans could eventually become non-performing.

On the 24th, the Bank of Korea analyzed the commercial real estate market trends in the "2020 First Half Financial Stability Report" approved at the Monetary Policy Committee meeting. Commercial real estate loans have short maturities and a high proportion of lump-sum repayments, which could increase delinquencies and defaults, especially among borrowers with medium to low credit ratings.

Applying a scenario where commercial real estate prices fall by 20% over the next year and rental income yields drop to half of those during the global financial crisis, the Bank of Korea estimated that financial institutions would face an additional burden of approximately 2.6 trillion KRW in loan loss provisions. Due to the decline in returns on financial investment products such as real estate funds and REITs, the scale of investment losses for financial institutions is expected to reach 600 billion KRW. As of the end of March, the exposure size of commercial real estate funds and retail/office REITs was estimated to be 15.5 trillion KRW.

Lee Min-gyu, head of the Stability Analysis Team at the Bank of Korea’s Financial Stability Department, said, "Previously, we mainly analyzed real estate loan exposure and risks, but we decided to analyze structural issues as well." He added, "The commercial real estate market is not currently experiencing a fire sale, but since it is one of the asset markets sensitive to the economy, there could be concerns."

Looking at the "number of retail property transactions" during the economic cycle phase of the commercial real estate market, the number of transactions decreased from 140 at the end of last year to 134 as of April. The trend shows a decline with 139 transactions in January, 137 in February, and 136 in March this year. A representative from a major commercial bank said, "In cases like retail properties, even if defaults occur and properties are put up for auction, often there are no buyers coming to view the auction items."

Meanwhile, the current commercial real estate market has shown signs similar to the late boom and early recession phases, with prices rising for over 40 months and transaction volumes decreasing. If the economic downturn deepens, there is a possibility of entering the recession phase somewhat quickly.

This content was produced with the assistance of AI translation services.