Following a detailed article I published with Business Spectator yesterday summarising recent RBA research that backed our historic arguments that--at the portfolio level--commercial property is riskier than residential property (in spite of many myths to the contrary), the AFR has run a follow-up today on the same subject quoting me:
Caution on commercial sector
Australian Financial Review
22 June 2010
Ben Wilmot
A study by Reserve Bank of Australia economists has found that commercial property and property development have posed a greater direct risk to financial institutions’ balance sheets than housing and mortgage markets. The findings, in a paper by Dr Luci Ellis, head of the Australian central bank’s financial stability department, and Chris Naughtin, also of the department, temper the notion that problems in the US sub-prime residential mortgage market were to blame for the financial crisis. The RBA paper argued that in both the current cycle and previous ones, the downturn in commercial property and development markets had “generally been more severe than in housing markets”. This made the effect on bank loan losses also “generally greater”. Bank exposures in Australia to problem commercial property loans include those made to Centro Properties Group and trusts formerly run by Allco Finance Group. The RBA pair were cautious about current conditions in commercial property but noted the local problems were smaller than offshore. “The outlook for commercial property markets and lenders in the major countries remains challenging as vacancy rates continue to rise and prices and rents are yet to recover. It is noteworthy, though, that loan losses on commercial property in Australia during the recent period have been relatively small compared with those in the United States and in some countries in Europe,” they wrote. The crisis has severely hit US and European commercial property markets, with large declines in asset values and sharp falls in asset quality. The RBA paper said bank loans to commercial real estate tended to be more concentrated in construction than lending to housing. It said imbalances built up further because construction lags were longer and borrowers in the commercial real estate sector did not have the same disincentives to default as home mortgage borrowers. While the state of housing markets is important for financial stability, bank loan losses had historically been more concentrated in loans to corporate property developers than in loans to households, the paper said. The impact in Australia has been seen among smaller developers, particularly as lenders such as HBOS, St George Bank and Suncorp have looked to cut their exposures. The RBA paper notes that “in Australia, much of the increase in exposures and non-performing commercial property loans has been seen among the smaller and foreign-owned banks”. Property analysts say that even large developers have not been profitable during the crisis. Merrill Lynch head of real estate equities research Simon Garing said: “We agree it is very important to distinguish between banks lending for commercial developments, which is high risk, versus banks lending for income-producing commercial assets.” “We have not seen a material deterioration in the ability for major owners of income-producing commercial property assets to keep paying interest as tenant defaults are low and major market vacancies are low by historical standards as most tenants avoided bankruptcies during the GFC.” Mr Garing said loan-to-valuation tests might be in breach in some cases as there were credit-related valuation issues, not underlying cash-flow issues. “The major A-REITs have generally been recapitalised and can raise debt for developments. Smaller listed and unlisted developers, however, can’t as they don’t have the income-producing asset base from which to borrow against.” Rismark International managing director Christopher Joye has long questioned commonly held assumptions that housing investment is more risky than commercial property. “The notion that commercial property is safer than residential housing is a myth and has been comprehensively dispelled by the RBA,” he said.
