The European Securities and Markets Authority (ESMA) has published its first ever report analysing risk exposures to real estate in EU securities markets and investment funds. Pointing out that downturns in real estate markets can be transmitted into other financial markets and the wider economy, the authority aimed to assess the effects of real estate market dynamics in the securities and investment fund segments.

The report identified three channels through which price falls in real estate markets can be transmitted into the wider financial system: bank exposures, non-bank exposures, and as collateral.

It observed “a broad-based decline of the main equity and bond real estate indices”, along with “increased trading activity and securities lending activity for real estate corporations”. “Credit institutions, particularly banks, and investment funds are important investors in the sector. They also belong to the main counterparties of some real estate firms in derivatives and securities financing transactions. Real estate-related securities are also found to be used as collateral,” the report wrote.

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“Interesting” challenge

The analysis suggested that “debt levels in the real estate sector are elevated with wider risk implications from non-bank financial market players” and that “interlinkages with the banking system are important and arise through entity exposures and activities. Through these, sector shocks may get transmitted across the EU financial system”.

Concluding that interest rate risks are likely to keep real estate market conditions challenging, ESMA warned that “credit risk indicators for real estate companies have started to show signs of deterioration and liquidity mismatches remain a key vulnerability for real estate investment funds”.