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Mr. Salih Fendoglu
This note analyzes the implications of changes in commercial real estate (CRE) prices for the stability of the US banking sector. Using detailed bank-level and CRE price data for US metropolitan statistical areas, the analysis shows that, following a decline in CRE prices, banks with greater exposures to CRE loans perform worse than their counterparts, experiencing higher non-performing CRE loans, lower revenues, and lower capital. These effects are particularly pronounced if the drop in CRE prices turns out to be persistent because of possible structural shifts in CRE demand—for example, because of an increased trend toward e-commerce and teleworking—even after the coronavirus disease (COVID-19) pandemic is over. The impact of a decline in CRE prices is especially true for small and community banks, which tend to have the highest CRE loan exposures. While the US banking sector has remained resilient during the pandemic crisis due to strong capital buffers and massive policy support, these findings suggest that continued vigilance is warranted with regard to potential downside risks to CRE prices amidst ongoing structural shifts in the sector.
Mr. Salih Fendoglu

to community banks headquartered in MSAs with a share of jobs that can be done at home greater than the 75th percentile and similarly for others. Solid bars indicate that the estimated relation is statistically significant at the 5 percent level of significance. CRE = commercial real estate; PPNR = pre-provision net revenue. Concluding Remarks The COVID-19 crisis has hit the commercial real estate sector hard in the US. The structural shifts in CRE demand pose considerable uncertainly around the outlook for the sector and suggest that further price

Mr. Salih Fendoglu

metropolitan statistical areas, the analysis shows that, following a decline in CRE prices, banks with greater exposures to CRE loans perform worse than their counterparts, experiencing higher non-performing CRE loans, lower revenues, and lower capital. These effects are particularly pronounced if the drop in CRE prices turns out to be persistent because of possible structural shifts in CRE demand—for example, because of an increased trend toward e-commerce and teleworking—even after the coronavirus disease (COVID-19) pandemic is over. The impact of a decline in CRE prices

Andrea Deghi, Mr. Junghwan Mok, and Tomohiro Tsuruga

reflect macroeconomic fundamentals (that is, fair values)—and use it to assess the extent of CRE price misalignment over the years, as well as the potential impact of a persistent decline in CRE demand going forward. We model fair value as a function of the expected income of the commercial property and the return of holding the property itself, building on the present-value relationship of Campbell and Shiller (1989) . As standard in the literature, the expected return on CRE properties stipulates that investors require risk compensation for exposure to the overall

Andrea Deghi, Mr. Junghwan Mok, and Tomohiro Tsuruga
The COVID-19 pandemic crisis has severely shocked the commercial real estate (CRE) sector, which could have important implications for macro-financial stability going forward because of the large size of the sector and its strong interconnectedness with the real economy. Using a novel methodology, this paper quantifies vulnerabilities in the CRE sector and analyzes policy tools available to mitigate related risks. The analysis shows that CRE prices were overvalued in several major advanced economies in 2020:Q1. It also shows that such price misalignments increase the likelihood of future price corrections and exacerbate downside risks to future GDP growth. While the path of recovery in the sector will depend inherently on the pace of overall economic recovery and the structural shifts induced by the pandemic, easy financial conditions may contribute to an increase in financial vulnerabilities and persistent price misalignment. Macroprudential policy can, however, be effective in curbing the financial stability risks posed by the CRE sector.