Chinese banks' substantial exposure to commercial real estate poses a risk to lenders if demand does not pick up.

At 8.87 trillion yuan in 2023, loans for office buildings, shopping malls and logistics facilities made up 5.2% of lenders' aggregate loan book, according to S&P Global Market Intelligence data. Loans to the sector amounted to 7.29 trillion yuan in 2019, when it accounted for 6.6% of total loans. Over the same period, banks' total exposure to the real estate sector, including residential and commercial, declined to 25.9% from 32.3%.

The biggest risk to banks' commercial real estate exposure is the country's economic growth, Gary Ng, senior economist at Natixis, told Market Intelligence. "If growth decelerates, then office demand will decline and retail vacancy will go up as consumers do not spend as much as they used to," Ng said.

On top of this, many households "are not keen to buy a house at this juncture," said Ng, which negatively affects banks' lending revenue.

China's GDP growth slowed to 4.7% year over year in the quarter ended June, from 5.3% year over year in the first three months of 2024, the National Bureau of Statistics reported July 15. The decline was primarily due to the weakness in the real estate sector.

The GDP slowdown was "broadly-based, with the services sector slowing significantly," Nomura analysts wrote in a July 16 report.

"The collateral damage from the sustained housing crisis appears to have impacted a broader range of sectors, especially those related to construction and consumption," they wrote.

China's five global systemically important banks (G-SIBs) — Industrial and Commercial Bank of China Ltd. (ICBC), Agricultural Bank of China Ltd., China Construction Bank Corp., Bank of China Ltd. and Bank of Communications Co. Ltd. — scaled back their aggregate commercial real estate exposure as a proportion of all loans to 4.73% from 5.49% between 2019 and 2023, according to Market Intelligence data.

As of the end of 2023, Bank of China had the highest amount of commercial real estate exposure at 1.47 trillion yuan, while Bank of Communications had the lowest at 0.49 trillion yuan. ICBC had 1.01 trillion yuan of exposure.

China's central bank and government want to avoid excessive speculation in the real estate industry, historically a key growth engine for the economy. The government is targeting a GDP growth of about 5% in 2024, after the economy expanded 5.2% in 2023, slightly exceeding a similar target.

Residential real estate difficulties often present a bigger economic challenge than that of commercial real estate, making this specific sector a focal point for analysts and investors. The government has announced a series of measures to support the residential real estate sector, and the People's Bank of China cut its benchmark rate for mortgages to an all-time low of 3.95% in February.

However, problems in the commercial property segment may be underappreciated. The vacancy rates of commercial properties in Beijing have climbed to nearly 20%, and about 15% of such properties in Shanghai are unoccupied, Ng said, noting the overall vacancy rate was about 10% before the COVID-19 pandemic.

"Supplies [of commercial property] can come back, and the increasing supply-demand gap may actually put pressure on some of the commercial property developers," said Ng.

Commercial real estate accounts for about 25% of China's property market, according to estimates by Jones Lang LaSalle.

"While also facing headwinds such as sluggish demand, especially in the office segment, and high growth of supply, it isn't likely that the commercial real estate will enter a prolonged downturn like its residential counterpart," Bruce Pang, chief China economist and head of research at the property consultancy company, said in an interview.

As of July 23, US$1 was equivalent to 7.27 Chinese yuan.