ECB Flags Potential Overvaluation of Eurozone Commercial Real Estate

The European Central Bank (ECB) has identified potential overvaluation of commercial real estate by some of the eurozone’s largest banks, potentially obscuring the deterioration of loans in a sector facing significant challenges. According to an ECB inspection, some banks may be inflating property values, failing to reflect the sharp market downturn driven by rising borrowing costs and reduced demand.

Commercial property prices have dropped sharply, with the ECB estimating a nearly 10% decline last year alone. The ECB’s Supervision Newsletter, released Wednesday, highlighted concerns about banks using outdated or inappropriate methods for valuing properties, potentially misrepresenting the collateral backing loans.

ECB inspectors found that some banks were relying on transaction data from 2021 or earlier to base their valuations, arguing that recent data was too sparse. However, the ECB emphasised that valuations must account for the current economic environment, including increased inflation and higher interest rates, rather than outdated market conditions.

The inspection also revealed that some banks were interpreting market value based on potential future sales prices rather than the present economic reality, and others were averaging multiple valuations without questioning the underlying methodologies.

The ECB cautioned that these practices could mask the true risks associated with commercial real estate loans, urging banks to adopt more accurate and realistic valuation methods in line with current market conditions.