(Bloomberg) -- Sweden’s heavily indebted commercial real estate owners remain vulnerable to rising borrowing costs and may need a 100 billion kronor ($9.6 billion) debt reduction, the country’s financial watchdog said.

Even as companies in the sector have sought to strengthen their balance sheets by offloading assets and raising new equity, more needs to be done, Finansinspektionen said in an analysis published on Tuesday. The agency estimates that if average interest expenses increase to 5% and property values fall by 20%, the real estate firms on average need to reduce their debt by about 15% to be able to keep profits at a higher level than credit costs. 

“They are in no position to relax,” the authority’s director-general, Daniel Barr, said in a statement. “They need to continue to reduce their debt and strengthen their equity to avoid a less controlled adjustment in the future.”

The comments from supervisory authority come after some some highly leveraged Swedish landlords have seen their credit ratings deteriorate and business models fall apart. The development in the Nordic country has become emblematic of challenges facing real estate owners worldwide as loans issued during an era of cheap credit will need to be paid back or refinanced at higher costs.  

Read More: Swedish Landlords Are Surprisingly Passive, Handelsbanken Says

While property owners including SBB, M2 Asset Management and Heimstaden Bostad AB have divested properties to shore up their balance sheets, far larger sales may be needed, according to Finansinspektionen. 

The agency estimates that if companies in the sector rely only on disposals to cut debt, they need to sell real estate for at least 300 billion kronor in the scenario where borrowing costs rise and values fall. That would be a tall order in a transaction market where only 44 billion kronor worth of properties changed hands in the first half of the year, according to research from Jones Lang LaSalle Inc.   

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In a separate report published Tuesday, Nordic Credit Rating warned that the sector’s headwinds are likely to continue, with an increasing impact of higher interest rates on companies’ credit metrics and continued declines in property values. 

The situation could also be exacerbated by an economic downturn that is beginning to weigh on unemployment in the Nordic region’s largest country. 

“So far, occupancy rates and operating margins are still strong, and we see limited impact on the companies’ business risk profiles,” NCR said in the report. “However, a significant slowdown in the Swedish economy could lead to increased vacancies over the next couple of years.”

Read More: Swedish Economy Stagnates as Rate Hikes Weigh on Output

Finansinspektionen said Swedish banks’ profitability and capital buffers mean they are resilient and could handle major credit losses, even if the situation should deteriorate more than expected. While media has so far focused on problems of large companies such as SBB and Heimstaden, the biggest threat to financial stability from the sector may lie elsewhere, Barr said.

“We see that it is the thousands of smaller companies in the sector that could pose a risk to the banks, and not the larger ones,” the director-general said in an interview. “As a whole, the sector has increased indebtedness too much and needs to address that, but it is a heterogeneous sector where some companies are very stable and others need to do more.”

(Adds details, comments from Finansinspektionen head from fifth paragraph.)

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