Malcolm Edey, Assistant Governor, RBA has been speaking about The Risk Environment and the Property Sector. His comments on the domestic scene are important, because he highlights not only risks in the hosing property sector, but also in the commercial sector, where a lot could also go wrong.
Our analysis has for some time focused on the buoyancy in parts of the property market and the leverage associated with that. Much of the focus has been on residential property, and I will start with that before turning to the commercial sector, where risks have also been growing. While the housing market has not been universally strong around the country, we have been seeing significant strength in the Sydney and Melbourne markets in recent times, with investors playing a large role. To summarise a few key facts:
- Housing prices in Sydney have increased by 31 per cent over the past two years, and reached an annual rate of increase of almost 20 per cent earlier this year.
- Melbourne prices were up by 16 per cent over the year to September this year.
- The value of loan approvals to investors in New South Wales approximately doubled over the two years to mid-2015.
As a result of these developments, the household debt ratio has started to edge up again from a level that was already high, at around 1½ times annual income (Graph 3).
Graph 3
It is against this background that the Reserve Bank has highlighted the need for prudence, and has supported APRA and ASIC in the measures that they have taken to strengthen lending standards.
As a general proposition, mortgage lending standards in the post-crisis period have been relatively tight, at least more so than before the crisis. Low-doc loans are rare, genuine savings are required to fund at least part of the deposit, and the application of interest rate buffers in serviceability assessments has become common. Nonetheless, investigations by APRA and ASIC have shown that there was some slipping in lending standards and that they were inadequate in some important respects to the current risk environment. Specifically, APRA found that, in some instances, lenders’ serviceability assessments were based on over-optimistic judgments about the reliability of borrowers’ incomes, or inadequate estimates of borrowers’ living expenses, or that they failed to take into account the possible effect of future interest rate movements on a borrower’s existing commitments. ASIC’s review of interest-only lending practices made similar findings, and also noted instances where the lender did not make reasonable inquiries as to whether the loan product was suitable to the borrowers’ circumstances.
Further to those findings, as a result of the additional scrutiny over the past year and substantial data revisions made by the banks, we now know that the level of investor activity in the housing market was in fact higher than previously thought.
As you know, APRA announced a number of supervisory measures in December last year to strengthen mortgage lending standards. These measures included expectations that:
- banks should not be increasing their share of higher risk lending
- growth in investor lending should not be materially above 10 per cent
- appropriate interest rate floors and buffers should be applied in serviceability assessments.
It will take time for the full impact of these measures, and of the more recently announced increases in bank lending rates, to become apparent. Nonetheless, the indications to date are that the supervisory measures are having a beneficial effect on lending standards and are assisting in restraining new investor finance. There is also some tentative evidence that sentiment may now be turning in the housing markets in the two largest cities. But it is much too early to be definitive about that. What we can say is that the risks in that sector are now being more prudently managed than they were a year or so ago.
The second main area of risk focus domestically is in commercial property. Historically this has been a common source of financial instability both here and abroad. During the height of the GFC, Australian banks remained in comparatively good shape but they did suffer a noticeable deterioration in asset performance, with the aggregate non-performance rate rising to just under 2 per cent of loans. A significant part of that deterioration was in commercial property lending; impaired commercial property exposures accounted for around 30 per cent of Australian banks’ non-performing domestic assets at that time.
After the post-crisis downturn, the commercial property sector is again experiencing strong investor demand, and bank lending to the sector is increasing. However there are a number of signs of increasing risk. Trends in commercial property prices and rents have been diverging over the past few years, with prices continuing to rise while rents have been flat to down (Graph 4). As a result, yields have declined. At the same time, vacancy rates have been increasing.
Graph 4
As in the housing market, conditions have not been uniform across the country, and they have been noticeably firmer in Sydney and Melbourne than in other centres. But in aggregate, the major categories of commercial property have all seen downward pressure on yields over recent years. Strong demand from foreign buyers has contributed to this, reflecting the global environment of low interest rates and ‘search for yield’ (Graph 5). The risks appear manageable at this stage, but they underscore the need for sound lending practices and for appropriate prudence by investors.
Graph 5
