For all our obsession with house prices and the latest missive from international bodies like the OECD warning about property bubbles, in fact property crashes don’t start in housing. Financial regulators such as the Reserve Bank and the Australian Prudential Regulation Authority have been pointing out for years that crashes start in commercial property. That’s what we saw in the financial crisis when bad commercial property loans in Sydney, Melbourne, Brisbane and especially the Gold Coast and the Cairns area of North Queensland triggered huge losses, and it was the trigger for the crunch in the early 1990s. And alarm bells should be ringing now about commercial property lending because of weak management and poor lending standards.

In 2015 the regulators, led by APRA, checked residential property lending standards for owner occupiers and investors and found rorts in interest-only loans, poor disclosure, inadequate information and knowledge of borrowers by lenders (which include the big four banks and dozens of smaller groups). That led to a significant tightening of standards, especially on investor borrowings, especially by self-managed super funds.

Last year, they went through commercial property lending (which includes larger apartment lending to developers and investors), and what they found was enough to prompt more tightening of standards — which may flow through into lending and prices. In a letter to lenders this morning, APRA noted:

  • “In current market conditions, it is important that the Boards of ADIs (Authorised Deposit-taking Institutions) are conscious of the settings for underwriting standards and portfolio controls, and in a position to challenge
    as appropriate.
  • In particular, Boards should actively challenge whether expectations of growth in commercial property lending are achievable, given the position in the credit cycle, without compromising the quality of lending.
  • APRA’s review revealed that the ability of the Board and senior management to fully understand and challenge the risk profile of lending has often been hampered by inadequate data, poor monitoring and incomplete portfolio controls. APRA expects ADIs to improve their capabilities in this area, and has written to individual ADIs with specific requirements in these areas.”

In an attachment to the letter detailing the problems it found, APRA identified lending too much on investment loans; inadequate considering of loan-to-valuation ratios “in light of recent strong asset growth”, problems with lending to developers, inadequate information on refinancings, problematic standards on presales (and what is a presale), lenders using so-called mezzanine finance and rising property values to allow developers to contribute less “hard” capital to the financing of a project, and — a major surprise — the way some lenders have ignored the oldest adage in property, “location location location”, with APRA saying it was concerned about “potential marketability issues for properties, such as being poorly located, small apartments lacking in amenities and/or suffering from design issues, was not always evidenced in transaction analysis”. 

For a government fighting off calls for a royal commission into banks because of weak oversight on their insurance subsidiaries and financial advice, the last thing they will want is a group of moaning investors and developers joining the calls for an inquiry as their deals go south. All the issues identified by APRA would be enough, over time to trigger an apartment sector shakeout and possible crunch, especially as a glut of finished properties emerges. And that in turn would threaten the financial system as a whole and could end our long period of positive economic growth. 

Peter Fray

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