In 2023, more than a third of all known CRE exposure was concentrated in equity REITs, mortgage REITs, and property funds, the FSB reported. The risks do not stop at smaller banks. Researchers from the NYU Stern School of Business, Georgia Institute of Technology’s Scheller College of Business, and the Frankfurt School of Finance noted in 2024 that, once indirect exposures through credit lines are considered, even the largest U.S. banks face significant vulnerabilities. The danger intensifies during periods of market stress, particularly when CRE REITs experience drawdowns to fund investor redemptions, which can create collateral damage across the banking sector.
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The FSB’s latest paper highlights three main vulnerabilities facing REITs and property funds. The first is the liquidity mismatch in some open-ended property funds, which hold only a small portion of their assets in liquid form. This makes them susceptible to sudden investor withdrawals, or “runs.” The FSB observed that several open-ended property funds were forced to restrict redemptions due to illiquid market conditions—a scenario that played out repeatedly for Starwood’s and Blackstone’s REITs since late 2022. Only recently have signs of recovery begun to emerge. To address these mismatches, the FSB suggests measures such as redemption gates, suspension of redemptions, or segmenting funds and redemption rights by CRE category. However, the FSB also notes that liquidity mismatches tend to be less severe in REITs compared to open-ended funds.
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The second major vulnerability is the existence of highly leveraged REITs and property funds. When debt exceeds 90% of a fund’s assets or is more than ten times a REIT’s equity, the risk of shock propagation through the CRE market and financial system increases dramatically. A drop in property valuations could trigger forced deleveraging, compelling investors to sell assets to meet debt obligations, which could further destabilize the market.
Finally, the FSB points to the inherent opacity in property valuations and the recognition of losses in CRE investments. Greater transparency—or at least ensuring that nonbank CRE investors adequately account for this uncertainty—remains a crucial challenge for the sector.