RBA notes concerns about inner city apartment glut

The RBA says over the past six months, domestic financial risks have shifted from housing lending towards lending for residential development and some other commercial property markets, and there are ongoing concerns associated with the challenges in the resource-related sector.

It suggested a glut of inner city apartments and an influx of Chinese money into the property market was shifting the risks in the banking system.

In its most extensive warning yet of the indirect risks facing the Australian property market, the Reserve Bank's Financial Stability Review warned that the supply of new apartments in major metropolitan cities could "weigh on prices and rents," which could reduce the income of property investors and make it harder for them to sell.

"With the demand for apartments softening in some areas … and households facing tighter access to credit, settlement failures might increase," the RBA advised.

It noted the actions of the regulators since late 2014 have helped induce a tightening of authorised deposit-taking institutions’ (ADIs) housing lending standards, and housing market conditions have moderated since the previous RBA Review.

"In particular, the share of high loan-to-valuation lending has taken a noticeable step down and tighter serviceability metrics have reduced maximum loan sizes.

"ADIs have also increased advertised interest rates for investor loans relative to owner-occupier loans, while providing larger discounts for some owner-occupier lending.

"These developments have contributed to a moderation in the pace of investor credit growth, though the effect on growth of overall housing credit has been largely offset by a pick-up in owner-occupier lending.

"While the household debt-to-income ratio has increased a little further, mortgage buffers in offset and redraw facilities are rising strongly, which helps to mitigate any associated risks.

"While these developments have generally enhanced resilience in the household sector, the tighter access to credit for households could pose near-term challenges in some medium- and high-density construction markets given the large volume of building activity that was started several years ago.

"These apartments are popular with investors and foreign buyers and any concerns over settlement risk and/or a slowdown in demand for Australian-located property by Chinese and other Asian residents could lead to difficulties for particular projects, though there is little evidence of either occurring so far. Risks seem greatest in the inner-city areas of Melbourne and Brisbane, where new supply is most geographically concentrated, and increasingly in Perth."

The RBA noted some other commercial property markets were also adjusting with a lag to a slowing in demand.

"This is most noticeable for office buildings in the resource intensive states, where vacancy rates remain very high as further supply continues to come on line.

"More broadly, commercial property yields have compressed across a range of market segments and there are some questions over their sustainability at these levels once global interest rates normalise."

In the rest of the business sector, the balance sheets of resource-related companies have come under strain following the large falls in global commodity prices over recent years and interest payments are taking an increasing share of earnings for the smaller producers and mining-related services firms.

The RBA noted none of the "domestic risks appears to be enough on their own to seriously degrade the near-term functioning of the domestic financial system, though they could exacerbate a major shock from elsewhere, such as a global economic downturn."

"In any case, Australian-based banks have taken further steps to increase their resilience to potential risks.

"As noted, ADIs have tightened their housing lending standards to align them with the prudential regulator’s expectations.

"While lending to the commercial property sector by the Australian major and Asian banks has continued to rise, many ADIs have tightened lending standards in this area and have reportedly become quite cautious in lending to certain parts of the sector."

The RBA noted banks’ non-performing loans remain low overall: while they have picked up for resource-related lending, banks’ exposures to this sector and to mining services firms are small.

"That said, some foreign banks operating in Australia have much higher shares of their total lending to this sector.

"Bank profitability has also remained high and capital levels have increased substantially in the past year.

"Nonetheless, with banks now competing intensely for lending in a narrower range of markets, it will be important that their serviceability and other lending standards remain appropriate."