Assessing Real Estate Risks: Uncovering Vulnerabilities in the Euro Area

Introduction

Real estate markets underpin financial stability across the euro area. With property-backed loans accounting for roughly one third of all bank lending, any downturn in prices or rise in non-performing exposures can ripple through the entire financial system. This article examines recent trends in property prices, mortgage portfolios, credit quality, lending practices and the role of non-bank financial intermediaries, highlighting key vulnerabilities and policy implications for a more resilient market.

1. Real Estate in the Euro Area: An Overview

1.1 Residential vs. Commercial Trends

Between 2016 and 2019, both residential and commercial property prices in the euro area saw steady increases, supported by low interest rates and looser lending standards. During the pandemic (2020–2021), residential prices continued climbing as demand shifted toward home-based lifestyles, while commercial real estate (CRE) stalled, especially office and retail space.

Since 2022, the rapid rise in interest rates cooled the housing market and triggered sharper corrections in CRE, where leveraged finance is widespread. Although 2024 brought some relief in borrowing costs, commercial valuations remain well below early-2021 levels.

1.2 National Variations and Access to Credit

Mortgage borrowing and housing affordability vary widely across Member States. High-wealth households generally maintained access to credit, while low-wealth buyers faced growing barriers. For more insights into housing trends across Europe, see our European housing analysis.

Per-capita mortgage debt ranges from over €25,000 in countries like Belgium and Ireland to under €5,000 in Latvia and Greece. These disparities reflect differences in income distribution, lending standards and the presence of non-bank credit providers.

2. Mortgages, Credit Quality and Borrower Resilience

2.1 Non-Performing Loans and Stage 2 Exposures

Despite price corrections, major banks in the euro area have maintained relatively low non-performing loan (NPL) ratios on property-backed lending. However, Stage 2 loans—those that have experienced a significant increase in credit risk since origination—have risen over the past four years, especially for commercial exposures.

2.2 Interest Rate Shocks and the Fixed-Rate Cushion

The shift to fixed-rate mortgages has been a key buffer against interest rate volatility. Since 2015, more than 80% of new housing loans have carried fixed rates, creating a large pool of low-cost debt that is insulated from recent policy tightening. In September 2024, household debt-to-income ratios fell to 84% from highs above 95%, enhancing borrowers’ ability to service loans even as market rates rose.

Nonetheless, significant differences persist: in some Member States, variable-rate loans still represent over 20% of new originations, leaving those borrowers more exposed to future rate increases.

3. Lending Practices: Why Standards Matter

3.1 Origination Criteria and Debt Ratios

Lending standards at origination—loan-to-value (LTV), loan-to-income (LTI) and debt-service-to-income (DST) ratios—play a decisive role in long-term credit risk. Studies show that a 10-point rise in LTV at origination can increase default probability by around 0.2%, while higher LTI and longer maturities also elevate risk. Harmonizing these metrics across banks can curb future waves of defaults.

3.2 Collateral Valuation and Loan Monitoring

Supervisory reviews have identified gaps in how banks value and monitor property collateral. Roughly 40% of new residential loans lacked an independent appraisal, and many lenders overlook factors like energy performance—now critical to long-term asset values. In the CRE sector, inconsistent “market value” definitions and outdated data pose further risks. Strengthening valuation practices and timely reviews would improve the resilience of loan portfolios.

4. Beyond Banks: The Shadow Banking Role

4.1 Real Estate Investment Funds and Liquidity Mismatch

Non-bank financial intermediaries, especially real estate investment funds (AIFs), have grown rapidly: assets under management rose by 375% over five years, reaching €1.5 trillion in 2022. While two-thirds of their holdings are illiquid physical assets, many funds allow frequent redemptions. A mismatch between liquid liabilities (investor redemptions) and illiquid assets can trigger “first-mover” runs in a downturn.

4.2 Contagion Channels to Banks

Although banks directly hold only about 5% of fund assets, they are key lenders to AIFs. Linkages vary by country, with concentrated exposures in markets such as Germany. To explore the wider impact on banking stability, refer to our report on real estate risks and financial stability in the European banking system.

5. Policy Implications and Best Practices

• Promote harmonization: Reduce national asymmetries in floating-rate usage, loan costs and access for low-wealth households.
• Standardize debt metrics: Align LTV, LTI and DST ratios across Member States and financial institutions.
• Balance provisioning and procyclicality: Encourage forward-looking capital buffers without forcing excessive write-downs that may amplify downturns.
• Monitor non-bank channels: Enforce transparent reporting for AIFs, mandate adequate liquidity management tools under AIFMD, and track interconnections with banks.
• Adopt a holistic approach: Supervise all funding sources—traditional banks, shadow banks and capital markets—so that no single channel bears a disproportionate burden.

Conclusion

Real estate exposure accounts for a significant share of euro-area bank lending and is a critical source of financial vulnerability. While current indicators are manageable thanks to fixed-rate mortgages and resilient borrower metrics, structural gaps remain in lending standards and non-bank financing. A coordinated policy framework—harmonizing national practices, enhancing collateral valuation and extending oversight to shadow banking—will be essential to safeguard stability and foster a more integrated, resilient property market.