A shudder went through investors in European bank shares this week when Deutsche Telekom announced a €2bn ($1.8bn) charge in connection with write-downs of property assets.
Brian Crossby, European banking shares analyst at ABN Amro, says the announcement prompted a flurry of phone calls from anxious bank investors who recalled the disastrous effects of lending to real estate in the last recession.
As a practical matter, Mr Crossby says, investors need not be worried. The move was simply a tidying-up exercise for Deutsche Telekom as it prepares to sell off its property assets, and should not be interpreted as a bell-wether of future property values.
But with a sharp slowdown in US economic growth, falling share prices and rising corporate bankruptcies, investors in, and lenders to, real estate are on their guard.
The question is whether losses sustained by banks in the early 1990s have forced lenders to disavow decades of excessive lending or whether they have once again succumbed to a go-go property market and resumed speculative financing. "There is a saying that banks have the collective memory of a goldfish," warns Mr Crossby.
Developers and investors who default on loans send a ripple through the wider markets as banks try to unload their collateral at fire-sale prices. In those circumstances, even well-let properties face some risks.
Moreover, he says, the dangers of a collapse in real estate values pose far greater risks to banks than is covered by their real estate exposure. "Real estate forms the basis of most forms of collateralised lending," he says.
All sorts of corporations have loans secured on their property assets, and a fall in values could force borrowers to trim their bank lines or put up more collateral, he notes.
On the face of it, signs of a slowing world economy are creating only a few ripples in real estate values in Europe and the US.
Property consultants Jones Lang LaSalle, in their annual review of European office markets, for example, found that average annualised returns in 2000 were 27 per cent, the highest level since 1990. Take-up in those markets exceeded 9.9 million sq m, well above the average take-up of 5.7 million during the past decade.
Best of all, speculative building has remained very low, with the amount of available space at the end of the year at its lowest point since 1994, while the average European vacancy rate was at its lowest since 1988 - the cusp of the last recession.
In Europe, lenders are still smarting from the painful lessons they learned a decade ago.
In the US, where banking regulators pay particularly close attention to real estate lending, the picture appears equally benign. In a recent research note entitled "This Time It's Different", analysts at Bank of America Securities concluded: "The trend of dramatic overbuilding seen in past real estate cycles appears to have ended."
Citing data from real estate forecasters Torto Wheaton, new supply of almost every property type is likely to be restrained over the next few years. "The primary reason for this," the analysts say, "is that capital availability has been limited, especially on the private side."
Moreover, the sharp rise in commercial rents experienced in so many US markets, where rents are often pegged to move at no more than inflation, many real estate portfolios are reversionary. Even if rental growth softens, there is far more cash to be extracted from property portfolios and banks are well protected against nasty surprises.
Nevertheless, the US Federal Deposit Insurance Corporation - the guarantor of deposits at banks that go bust - sees the need to remain vigilant. Last autumn, it took the unprecedented step of naming 13 US markets that it believes have the potential for overbuilding.
Indeed, so great is the concern about the impact of real estate finance on bank solvency that US banking analysts at UBS Warburg have recently published a report examining the exposure of the industry to property lending.
"Do we think bank stock investors have something to worry about?" the analysts ask. "Our short answer is no, provided we are not facing a recession."
The analysts point out that as a percentage of total lending, commercial real estate loans are well below their levels in December 1991, although above the trough reached in December 1996.
Even better, as a percentage of non-performing loans, real estate are but a small fraction of the total compared with 1990 where they were nearly 20 per cent of all non-performing debt.
What happens to real estate in a recession, however, could be anybody's guess - a point UBS Warburg analysts underscore.
All the research, they say, has comforted readers with the news that supply remains in check. If occupier demand falls sharply as a result of an imminent recession, all bets are off.
The UBS Warburg analysts point to one specific sector of the US real estate industry that might be vulnerable. Noting that occupancy rates in the high-technology corridors in California, Virginia and Washington DC have been fuelled by dot.com start-ups and the expansion of telecommunications and Internet service providers, the analysts point out that some weaker credits are already giving back space to landlords.
