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RBA has commercial property on its radar

AAP logoAAP 14/10/2016 Garry Shilson-Josling, Economist

The Reserve Bank is concerned that low yields could make the commercial property market vulnerable to an exodus of foreign buyers or a rise in interest rates in other countries.

Yields on Australian commercial property are higher than in many other markets around the world and that has attracted the attention of foreign investors, especially in Sydney and Melbourne, the RBA said in its half yearly Financial Stability Review on Friday.

The lift in demand from investors has pushed prices higher, relative to rents, meaning rental yields have fallen, most noticeably in the office and industrial property markets.

"One concern is that the current low level of yields could prove unsustainable, particularly if global interest rates were to increase or demand from foreign buyers were to decline," the RBA said.

If either of those risks materialised and weighed on property values, it could cause borrowers to breach their loan-to-valuation covenants - conditions requiring the amount owed to be kept below a given percentage of the property's value.

They would then be required by their banks to come up with extra cash to support their loans.

"A decline in valuations would therefore be more likely to affect highly leveraged investors, who are usually closer to their covenant thresholds," the RBA said.

Another risk stems from weakness in leasing conditions in the Brisbane and Perth office markets, where rents have been falling in response to the downturn in mining investment.

The weakness in rents could hamper the ability of borrowers to service their debts, the RBA said.

Despite these risks, commercial property lending, including to residential property developers, has been growing strongly.

The RBA said the banking regulator, the Australian Prudential Regulation Authority, had begun a review of lending practices in these areas aimed at improving lending standards.

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