Commercial property a key risk for lenders
The Reserve Bank has identified the commercial property sector as a "key risk for lenders", with developers and other geared investors facing the prospects of breaching their loan covenants.This is despite the fact that overall, banks' commercial property exposures as a share of total banks assets are around 6 per cent.In its latest Financial Stability Review, the RBA said: "This is a key risk for lenders. 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."The RBA's view of the commercial property sector is that prior to the pandemic, the retail sector of the commercial property market was facing challenging conditions due to weak consumer spending and heightened competition. "The outlook for tenant demand for retail property has deteriorated, given the downturn in trading conditions, with declines in rents and increases in vacancies," the RBA said.Conditions in office markets were previously strong but these are also expected to deteriorate in the period ahead. 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.Asset valuations in property markets had increased to very high levels over recent years, both in Australia and overseas.In the period ahead, declines in both sales volumes and valuations are likely, reflecting the weakness in the rental market and a repricing of risk by institutional investors.For some geared investors, falling valuations will see them breach loan covenants which will need to be worked through with enders. For developers with projects still under construction but the unsold properties, it could be difficult to finalise sales a profitable price. Developers will then be left holding inventory and debt on their balance sheets with little or no revenue.Overall, non-bank lenders are particularly active in lending for the construction of commercial property, including apartments.