What Comes After PF?… Bank of Korea Detects Commercial Real Estate Deterioration

Concerns over domestic real estate project financing (PF) defaults are growing, and as the global commercial real estate market continues to slump, it is pointed out that this could become another factor shaking the domestic financial market. The Bank of Korea also warned of potential distress in the domestic commercial real estate market.

On the 3rd, the International Finance Center stated that caution regarding commercial real estate loan defaults, especially among banks, continues in the United States. Citing data from the National Bureau of Economic Research (NBER), the center analyzed that U.S. banks could face losses of about $160 billion (approximately 209 trillion KRW) in the commercial real estate loan sector, which accounts for about a quarter of their assets on average. This indicates an increasing possibility of real estate market distress spilling over to financial institutions.

This is due to the downturn in the U.S. commercial real estate market. The research institute predicted that office vacancy rates have risen due to increased remote work following the COVID-19 pandemic, causing office prices in New York to fall by about 40% by 2029. The prolonged high interest rates are another cause of the commercial real estate slump. As a result, delinquency rates on commercial real estate-backed loans at U.S. banks have increased, raising concerns about losses.

The situation is similar in Europe. Losses in the commercial real estate sector are surging in major countries such as Germany, France, and the United Kingdom. Due to the worsening real estate market, the holding company of Austria’s giant real estate firm Signa Group filed for bankruptcy in court last November.

View of the dense office building area in downtown Seoul as seen from Namsan, Seoul.
[Image source=Yonhap News]

The damage from the global commercial real estate market slump is extending to South Korea. Mirae Asset Global Investments invested a total of 978.6 billion KRW in office buildings in the Dallas area of Texas, USA, but ahead of the fund’s maturity last October, sold the building at about 20% below the purchase price for 787.9 billion KRW, incurring a significant loss. Investors in the fund filed complaints with the Financial Supervisory Service, claiming that Mirae Asset did not properly disclose the fund’s risks.

In the case of Aegis Asset Management’s 'Aegis Global Real Estate Investment Trust No. 229,' which invested in the Trianon building in Frankfurt, Germany, the cumulative loss rate has reportedly exceeded 80% since the fund’s inception. The total balance of overseas real estate funds sold by the five major domestic banks also reaches 753.1 billion KRW, raising concerns about potential losses.

The Bank of Korea also warned about the possibility of distress in the commercial real estate market. In his New Year’s address on the 1st, Governor Lee Chang-yong said, "Signs of distress in commercial real estate loans are appearing in major advanced countries," and added, "In South Korea, some risk signals are detected mainly in real estate PF, so special attention is needed to prevent credit risks from expanding around the weak links of our economy." Governor Lee also mentioned in a subsequent meeting with reporters that "Overseas central banks are highly concerned about the distress in the global commercial real estate market centered on the U.S."

According to the financial stability report released by the Bank of Korea last week, the average sales price per unit area (㎡) of domestic commercial real estate in the third quarter of this year was 5.86 million KRW, down 5.6% from the peak of 6.21 million KRW in the first half of last year. The transaction volume also declined by 26.7% year-on-year to 58,000 cases, showing a sluggish trend. Sales prices and transaction volumes were particularly weak in logistics centers and medium-to-large shopping malls.

Delinquency rates are also on the rise. The delinquency rate on commercial real estate-backed loans by non-bank financial institutions (such as savings banks and mutual finance) sharply increased from 1.6% in 2021 to 4.4% at the end of September 2023.

A Bank of Korea official emphasized, "While the possibility of a large-scale default of domestic commercial real estate-backed loans in a short period is low, the potential risk level has increased compared to the past," and added, "Financial institutions need to proactively respond to the possibility of loan defaults materializing due to continued oversupply of commercial real estate, delayed economic recovery, and interest rate burdens."

Meanwhile, while the office market in the U.S. and Europe has deteriorated due to the spread of remote work, South Korea’s office market is considered resilient as remote work has decreased since the end of the COVID-19 pandemic. The problem in Korea lies more with logistics centers and shopping mall markets than with the office market.

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