China can absorb its property crisis. Can the US and Europe say the same for theirs?

The US, the largest commercial property market in the world, has seen prices tumble since the Federal Reserve started raising interest rates
The knock-on impact of falling property prices on the banking system, securities markets and real economy could be serious, and reverberate into international financial markets

Anthony Rowley

Published: 5:30am, 28 Jan 2024

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China’s housing sector has problems, as most people are only too well aware from the seemingly endless barrage of press coverage on the issue. But how many realise that potentially more serious crises are brewing in US and European real estate?

As the International Monetary Fund (IMF) noted in a blog post on January 18, which attracted little attention compared to blanket coverage of China’s problems, the commercial real estate sector generally “has been under intense pressure as interest rates have risen over the past couple of years”. Other sources note trouble in European housing markets.

This is not to suggest that China’s property problems are not serious; they are. But what is regrettable is many commentators’ lack of perspective on how serious these are in global terms compared with those in the United States especially. It is a question of ignorance and bias.

Commentators, especially those who appear not to have experienced past real estate-linked financial crises that have occurred in places ranging from the US and Europe to Hong Kong and Latin America, fail to appreciate the significance of accompanying systemic risk.

Thus, while China appears able in terms of financial and fiscal resources to absorb the impact of its property crisis, retarding though this will be to economic growth, the same cannot be said of the US and of some European nations.

This applies especially in the case of the United States, which has the largest commercial property market in the world. Prices there have tumbled by 11 per cent since the Federal Reserve started raising interest rates in March 2022.

This drop is considerably steeper than in past monetary tightening cycles, the IMF notes, and it has erased all the gains of the previous two years – an ominous development not just for commercial real estate but for the US financial sector and the economy at large.

Higher borrowing costs always tend to dampen commercial property prices – directly by making investments in the sector more expensive, and indirectly by slowing economic activity and reducing demand for such properties. Nevertheless, the IMF notes, “the sharp decline in prices during the current US monetary policy tightening cycle is striking”.

US Federal Reserve chair Jerome Powell attends a press conference in Washington on December 13 last year. The Fed left interest rates unchanged at a 22-year high of 5.25 per cent to 5.5 per cent, signalling an end to its rate-hiking cycle and possible rate cuts next year. Photo: Xinhua

The wider implications of such developments are serious, for economists, bankers and financial analysts alike, as well as for investment institutions like pension funds that treat commercial property as an alternative asset to stocks and bonds.

The knock-on impact of falling property prices on a nation’s banking system, securities markets and the real economy can be serious – as Hong Kong, for one, has experienced in the past. In the case of the US, these knock-on effects can reverberate into international financial markets.

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Property sector developments are (or should be) of considerable interest to journalists in their role as watchdogs of the public interest. Excesses or “bubbles” have a way of creeping up unawares on commentators – or even regulators.

While many people are currently obsessing about China’s housing crisis, they seem to be paying far less attention to developments in commercial property markets and – even more dangerously – in wider debt markets.

If a crisis should be triggered by falling commercial property valuations and consequent debt distress – also among household mortgage holders unable to service their obligations – banks have less leeway now to finance bailouts than they did in the past. They have splurged on lending to property and other sectors during a long period of low interest rates and will not wish to indulge in more of the same now. Governments, meanwhile, have pumped up fiscal stimulus and need to pull back rather than plunge in afresh.

Customers shop at a retail store in Vernon Hills, Illinois, on June 12, 2023. Trends, such as remote working and e-commerce, have led to drastically lower demand for office and retail space. Photo: AP

The same shortsightedness (or bias) that drives overconcentration on China’s property-sector issues creates an inability to grasp the importance of record global debt and surges in interest rates. Yet another global financial crisis could occur before interest rates fall.

Falling real estate valuations will be an important contributing factor. As the IMF notes, commercial property prices remained “generally stable” during past Fed rate hikes. It says that the difference in price behaviour between the recent and past monetary policy tightening cycles could partially be explained by “the steep pace of monetary policy tightening this time around”, which “contributed to the sharp increase in mortgage rates and commercial mortgage-backed securities spreads”.

As a result of higher financing costs since beginning of the tightening cycle and the decline in property prices, commercial real estate loans have seen growing losses. With US banks adopting stricter lending standards, available funding has been squeezed.

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All this has been compounded by trends, such as teleworking and e-commerce, that have led to lower demand for office and retail buildings and pushed vacancy rates higher. Prices have slumped in these segments, and delinquency rates on loans risen, which is worrying as high volumes of refinancing are coming due.

Meanwhile, the housing market in parts of Europe is suffering from falling valuations, along with rising interest rates. A study by Swiss Bank UBS examining 25 of the largest cities across the world, shows that real house prices fell by 5 per cent on average from mid-2022 to mid-2023 and that this trend is likely to continue.

The message to analysts and financial journalists as well as investors and policymakers is that the property market needs watching closely, and by no means only or even mainly in China.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs