It's not just the housing market that has the Reserve Bank of Australia worried.

Sure, high housing prices and the risks they pose to the banking system and the economy are the talk of the town.  But there’s another blip on the radar screen – commercial property.

In its latest half-yearly report on the stability of the financial system, the central bank said risks in this area appear to be building.

Even if individual borrowers appear to be safe, lenders should be “mindful of the collective effects of strong lending activity within particular market segments”.

In other words, pumping money into a property market can turn safe borrowers into bad risks if prices fall.

And the RBA is concerned that lenders, especially foreign banks operating in Australia, have been cutting their prices in order to gain market share.

That’s a worrying thought for anyone old enough to remember the entry of foreign banks into the Australian market in the 1980s, their efforts to buy market share through aggressively priced and risky loans, and the contribution of that to the ensuing economic recession.

And, while the commercial property market is not yet at centre stage as it was in the 1980s, it’s in the wings rehearsing its lines, waiting for its moment in the spotlight.

The effects on overall financial stability so far have been “modest”, the RBA said, implying it won’t stop the RBA from cutting interest rates in the coming few months as most economists expect.

But the risks appear to be rising.

“Competitive pressures appear to be most pronounced in the commercial property loan segment, despite falling yields and an emerging oversupply in some major capital city markets,” the RBA said.

In a world of low interest rates and a highly-priced share market, the search for higher yields has boosted investor demand for commercial property, particularly from offshore investors.

That’s continued to push prices up and yields down around the world, including Australia.

At the same time, the leasing market is still soft in many local markets and oversupply is emerging in the Perth and Brisbane office sectors.

“These dynamics increase the vulnerability of the commercial property market to a price correction,” the RBA said.

And it referred explicitly to the late-1980s property market slump, warning lenders to be “especially cautious” in valuing properties and setting loan-to-valuation ratios.

“They should also ensure they do not build up concentrated exposures within this sector (e.g. by geography, property segment or developer), as these can give rise to correlated losses for lenders, as occurred during 2008-09.”


By Garry Shilson-Josling