The central bank of Australia has issued a warning of the deteriorating conditions in the markets for commercial property, with banks and developers being exposed to property valuations that are too high.
In its April Financial Stability Review, the Reserve Bank gave a grim forecast detailing that the period ahead would experience declines in volume and sales and valuations, which reflects how weak the rental market is and how repricing risks face institutional investors.
This review came after the government introduced a mandatory code of conduct that requires landlords to consider rent reduction for tenants who are struggling with the decline in their revenue. This will be 50% waived and 50% deferred.
The retail sector also experienced a risk due to the coronavirus, which caused a downturn in the economy, and this is according to the Reserve Bank.
According to the Reserve Bank, there has been a deterioration of the outlook for retail property demand from tenants, which has been caused by the downturn in trading conditions. This has resulted in the decline of rents, and vacancy rates increase.
The prices for commercial property have also risen faster compared to rents in the past few years, and this is all thanks to the decline in interest rates. Therefore, this shows that a lot of property owners will struggle in case tenants are unable to pay their rent.
This could cause some investors to breach loan covenants, while developers that still have projects under construction can find it difficult to close any sales at a profit. Such an issue estimates that most developers will be left with their inventory and even debt on their balance sheets resulting in a lack of revenue.
According to the Reserve Bank, valuation firm in property markets experienced an increase to high levels in the last few years both in the country and overseas. Banks have suffered losses from loans on construction in the past, and this has grown at a faster rate even though it only accounts for a small percentage.
Approximately 6 percent of the banks' total assets are exposed to commercial property. Still, non-bank lenders have also been included by the RBA in that percentage, and this includes even apartments.
High risks also face office markets, and although they've been strong in the recent past, it is anticipated that they might drastically deteriorate. According to the Reserve Bank, some property funds with assets totaling 20 billion pounds suspended their redemptions due to the uncertainty in valuation and inability to sell quickly.
It is also estimated that the demand will not be able to keep pace with the upcoming strong supply since a massive volume of office supply is expected to the delivered into the markets of Sydney and CBD Melbourne this year.
According to Goldman Sachs, rent reduction will occur due to the high rise in vacancy rates in Sydney and Melbourne CBD to approximately 30 – 34%. The worst thing is that the demand will drop drastically after the completion of the recent office developments. This has caused Goldman Sachs to reduce its estimation of the operations' underlying funds for the large office landlords per security.
In the first quarter of this year, demand for office space in the CBD of Melbourne turned negative, and according to Mr. Randall, an analyst at Goldman Sachs, they expect the negative demand to remain the same for the entire year.