Lower Valuations a Challenge for Developers: RBA

The Reserve Bank has sounded its second warning in as many months about the risk of deteriorating commercial conditions on financial stability.

In its May minutes, the board said that rising vacancies and rapidly reducing rent income will pose challenges for leveraged property investors and developers.

Retail property, which was already experiencing falling capital values prior to the Covid-19 downturn, was particularly vulnerable. The board reiterated that Sydney and Melbourne office markets were not expected to keep pace with supply in the near term—adding to uncertainty in the sector.

The commentary echoed the US Federal Reserve’s concern for commercial property asset prices, which it flagged as a risk in its bi-annual financial stability report. The central bank said that US commercial real estate prices were “high relative to fundamentals before the pandemic” and remained “highly vulnerable”.

In the Asia Pacific, no deals over the $1 billion mark were struck in the first quarter compared with 11 in the US and Europe, Real Capital Analytics managing director David Green-Morgan said.

Transaction activity in Australian commercial markets nosedived by 50 per cent as major campaigns were suspended and FIRB thresholds lowered to prevent opportunistic investment.

“So far there have only been few indications of deals being terminated, suggesting that investors are adopting a wait-and-see approach rather than entering panic mode,” Green-Morgan said.

Related: Office Markets Under Pressure as Rent Outlook Sours

Savills national head of capital transactions Ian Hethrington said that activity had “hit a brick wall”.

“No one knows what a building is worth at the moment, and [while] there is plenty of capital on the sidelines they don’t know what the discount is to cover this market just yet,” Hetherington told The Urban Developer’s commercial property webinar last week.

CBA economist Craig James said that commercial real estate is an area to watch in coming months.

“Low utilisation and a low take up of space will keep downward pressure on valuations and yields. Landlords will need to be creative to lift occupancy and take-up rates.”

The Reserve Bank board also noted that lower incomes, confidence and population growth will affect demand for housing for an extended period.

“At the same time, the supply of rental housing had been boosted as properties that had previously been offered as short-term accommodation were shifted to the long-term rental market.”