Property valuations a risk for banks and developers, RBA warns – Sydney Morning Herald

"The outlook for tenant demand for retail property has deteriorated given the downturn in trading conditions, with declines in rents and increases in vacancy rates now likely," it said.

Commercial property prices have risen faster than rents in recent years given the decline in risk-free interest rates. More highly leveraged owners could struggle if tenants were unable to pay rent, particularly in the very weak retail sector, it said.

For some geared investors, that could mean they breach loan covenants, while developers with projects still under construction could find it difficult to finalise sales at a profitable price.

"Developers will then be left holding inventory and debt on their balance sheets with little or no revenue. This is a key risk for lenders."

Asset valuations in property markets had increased to very high levels over recent years, both in Australia and overseas, it said.

"Banks have incurred substantial losses from construction loans in past downturns, and while construction lending accounts for a small share of business lending, it has grown rapidly recently."

Banks exposure to commercial property is around 6 per cent of their total assets. But the RBA also highlights non-bank lenders who have been particularly active in lending for commercial property construction, including apartments.

It also points to risks in office markets. While previously strong, they are also expected to deteriorate.

"Of note, an above-average volume of office supply is due to be delivered into the Sydney and Melbourne CBD markets this year and demand will be unlikely to keep pace with this stronger supply," it states.

Goldman Sachs analyst Ian Randall has a similar view on office market risks.

Revised modelling by Goldman Sachs suggests rising vacancy rates will drive rent reductions for Sydney and Melbourne's CBD office markets of about 30 and 34 per cent between December 2019 and 2022, at least 12 per cent higher than its previous estimates.

The completion of multiple new office developments will coincide with a sharp drop in demand.

"We also expect near-term office net operating income (NOI) across the sector to be impacted by the need for assistance for tenants experiencing financial difficulty, and now assume that tenants accounting for 25 per cent of NOI receive three months of rental abatement across all office portfolios."

As a result, Goldman Sachs has reduced its estimates of underlying funds from operation per security for the big office landlords Dexus, GPT and Mirvac by between 3 and 8 per cent.

Net demand for office space in Melbourne's CBD turned negative in the first quarter of this year. "We expect Sydney CBD net absorption to remain negative over the balance of this calendar year," Mr Randall said.

Vacancy in Melbourne will more than double to 10.1 per cent by December next year and Sydney's will peak at 10.6 per cent by December a year later, Goldman forecasts.

Simon Johanson is a business journalist at The Age and The Sydney Morning Herald.

Carolyn Cummins is Commercial Property Editor for The Sydney Morning Herald.

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Property valuations a risk for banks and developers, RBA warns - Sydney Morning Herald