Nov 25 2017Add to Favorites
Jason Murphy, News.com.au
Think you’ve got enough to worry about? There’s a whole other real estate bubble in Australia that could wreak major damage on our economy.
We all know about the immense debt taken on for housing. Commercial property could be an even bigger risk. If we find ourselves in line at Centrelink in a few years time, the reason could well be a crash in commercial real estate.
The prices of offices, shopping centres, warehouses and new developments have shot up recently. That is making experts nervous, because commercial real estate is even more prone to booms and busts than housing.
These next three graphs show the prices of three kinds of commercial property over the past three decades. The blue lines for offices and industrial property go nearly vertical in the past few years, showing giant increases in price. But rents aren’t keeping up.
This market has the nation’s economists worried. The Reserve Bank of Australia sent its head of Financial Stability out this week to sound the alarm on commercial property, and to remind us of our history.
Australia went through a commercial real estate bust in the 1990s, cautioned the RBA’s head of Financial Stability Jonathan Kearns, and it nearly sent our banks broke.
“This was a classic boom-bust or ‘hog cycle’ story. The second half of the 1980s saw buoyant economic conditions, strong growth in commercial property prices and a large increase in commercial property construction,” Mr Kearns said.
“A ready supply of credit fuelled the boom. Following bank deregulation and the entry of foreign banks into the domestic market in the mid-1980s, the domestic banks competed to hold on to their market share. Lending standards were lowered.”
It nearly ended in disaster with office prices falling by half and banks teetering on the edge of a cliff, he added.
“Losses mounted at banks with two having to be rescued, and one major bank needing to raise capital,” Mr Kearns said.
When banks need to be rescued, you’re on the brink of a total economic disaster. Bank failure can create financial contagion that brings the economy to a standstill and tips thousands of people out of work.
When an Australian takes a loan for a house, they must pay it back or enter personal bankruptcy. That means loans get repaid. In America, in the housing crash, this was not the case. People could send their keys back and get out of their loan.
Banks ended up owning a whole lot of really crappy homes worth nothing.
Commercial real estate — including warehouse, shopping malls and offices — does not have the same structure as mortgages, Mr Kearns said. The lenders have much less incentive to pay back the loan.
“Losses can also be greater on lending for commercial property than for residential property because borrowers with a limited liability company structure have less incentive to repay than individual residential mortgage borrowers who face full recourse,” he said.
Loans that don’t get repaid is where lenders get in strife. And it doesn’t have to happen right now. It could be in five years when interest rates go up.
Another big difference between mortgages and commercial property lending is refinancing. Commercial property is rarely on a 30 year mortgage. Instead it will be on a shorter-term loan that has to be refinanced every few years. If interest rates are a lot higher at that time, the commercial property owner may not be able to get a new loan.
That sort of funding squeeze can trigger a fire sale that drives prices down and make it even harder for other commercial property developers to get financing.
Australia’s big banks are almost certainly safe enough to survive through a commercial property crisis. But our economy is stuffed chock-full of property developers, smaller financers and construction firms that could end up broke.
Their thousands of employees could end up jobless and their debts unpaid, which would ricochet through our economy, making life tough for everyone.
Australia’s major banks fed the commercial property beast for a long time. But in the last year or so, they’ve pulled back. In the next graph you can see the green line flattening out as they get cautious.
But the black line has been rising. That is largely explained by foreign banks. Asian banks have stepped up to the plate, dramatically increasing the amount they are lending to commercial property projects as this next graph shows.
In one sense this could be good news. Bank losses in Asia would not be good news, but they’re less damaging to Australia than local banks making big losses.
The financial risk is offshore, but the buildings are here in Australia. Any property could be bought cheaply by an Australian business if there is a distressed sale.
But it’s not good news if the foreign lending is puffing up a bubble that comes crashing down, damaging us all. Some of that foreign funding is exempt from Australian regulations, and so could be contributing to risky lending.
Mr Kearns certainly sees some concerning parallels to recent history. “This strong growth in commercial property lending by Asian banks is reminiscent of European banks’ growth in the lead up to the financial crisis,” he said.
If foreign banks decide in a few years that they made a mistake lending for Australian commercial property, they might suddenly stop lending. That can make a weak market enter a downward spiral.
SQUARE METRES FOR LEASE
So far, commercial property looks fairly sound in most of Australia. As the next chart shows, it is only Perth where office real estate vacancies have spiked.
The low vacancies in Sydney and Melbourne are a good sign, for now.
So long as those office towers are full of thriving businesses that can pay enough rent, we can keep commercial property developers from going broke. But if we get an economic shock and that breaks down, the shockwaves could spread a long way through our economy, and make us all worse off.
While the Reserve Bank of Australia has indicated cash rates will remain stable, lenders are increasing property borrowing rates by up to 25 basis points, in response to rising funding pressures.
Highly geared borrowers are charged higher interest rates, as well as mortgage insurance, the Commonwealth Bank has confirmed.
The recent contraction in bond yields could boost relative performance for locally listed properties, according to figures released by Citi, whose research concluded that the yield curve for Australian bonds is flattening again.
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