Commercial property vulnerability warning as RBA looks to tightened lending options
The Reserve Bank of Australia (RBA) is discussing additional steps that might be taken to reinforce sound lending practices, particularly for lending to investors, with the Australian Prudential Regulation Authority (APRA).
"The composition of housing and mortgage markets is becoming unbalanced," the RBA said in its latest bi-annual Financial Stability Review, issued today.
It also noted that "with attractive yields on Australian commercial property, many of the dynamics evident in investor housing are also playing out in this market, increasing the vulnerability of the commercial property market to a price correction".
The Reserve Bank noted that the low interest rate environment and, more recently, strong price competition among lenders had translated into a strong pick-up in growth in lending for investor housing.
"As a result, the composition of housing and mortgage markets is becoming unbalanced, with new lending to investors being out of proportion to rental housing’s share of the housing stock.
"Both construction and lending activity are increasingly concentrated in Sydney and Melbourne, where prices have also risen the most."
The bank observed that the risks are likely to be macroeconomic in nature, rather than direct risks to the stability of financial institutions.
"Property investors in Australia have historically been at least as creditworthy as owner-occupiers, and mortgage lending standards remain firmer than in the years leading up to the financial crisis.
"Even so, a broader risk remains that additional speculative demand can amplify the property price cycle and increase the potential for prices to fall later, with associated effects on household wealth and spending.
"These dynamics can affect households more widely than just those that are currently taking out loans: the households most affected by the declines in wealth need not necessarily be those that contributed to heightened activity. Furthermore, the direct risks to financial institutions would increase if these high rates of lending growth persist, or increase further."
It suggested the apparent increase in interest-only loans by both owner-occupiers and investors might also be consistent with increasingly speculative motives behind current housing demand.
"At this stage the main risk from this strong investor activity appears to be that the extra demand may exacerbate the housing price cycle and increase the potential for prices to fall later."
On the commercial property front, the bank noted strong demand for commercial property continued to boost prices, especially for CBD office and industrial properties, despite weak leasing conditions and subdued tenant demand in some states.
"In particular, lower demand from government organisations in Brisbane and mining- related companies in Brisbane and Perth has weighed on conditions in these CBD office markets.
"By contrast, the Sydney office market, where price rises have been greatest, has been somewhat shielded from the effects of weaker tenant demand, in part because withdrawals of property from the market (particularly the conversion of older office space to residential property) have constrained supply.
A substantial supply of office properties is under construction or being refurbished and is therefore expected to come online in the next couple of years in Sydney, Brisbane and Perth.
"Beyond this, industry liaison indicates that the current softness in tenant demand has led to some projects being delayed or cancelled, and building approvals have declined over the first half of this year. Supply-side pressure in the retail sector should remain limited, with the increase in construction activity over the past few years largely related to the refurbishment 80 and modest expansion of existing centres, and construction of large retail centres (occupied by a single retailer).
"One risk facing the commercial property sector is that a reversal in the strong growth in investor demand might expose the market to a sharp repricing.
"In particular, inflows of foreign capital could slow or cease once global interest rates start to rise or if conditions were to weaken in foreign investors’ home countries. The risk may also be exacerbated by further weakness in commercial property leasing conditions.
"Another risk facing commercial property lending, especially lending for new property development, is tenancy risk – that is, the risk that the developer fails to secure tenants for their property and consequently struggles to meet their loan repayments.
"This risk is higher for developments with a lower precommitment rate.
"For office property, the strength in investment demand and relative weakness in tenant demand have contributed to a decline in the average precommitment rate, though available data for selected years from the early 1990s suggest it remains significantly higher now than it was in the lead-up to the severe market downturn in the early 1990s."