Reserve Bank warns on glut of apartments

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ANOTHER CUT ON THE CARDS

The Reserve Bank has issued a fresh warning that developers may be sitting on a flood of apartments that fail to settle, flagging that the property supply glut will worsen, given that developments already under way are still running near record highs despite efforts to cool the market.

The comments came as the central bank gave its strongest indication yet that the cash rate would move closer to 1 per cent, signalling that another cut could be on the cards this year.

After this week cutting the cash rate to a record low 1.5 per cent, the RBA published updated forecasts that showed it expects inflation to track below its 2 per cent threshold for most of the period to the end of 2018.

This could support one critical area of the economy — housing construction — which continued to boom, particularly construction of apartments, the RBA noted in its quarterly statement on monetary policy released yesterday. However, with “years” of housing investment activity still in the pipeline, this could have implications for pricing or heightened settlement risk.

“Building approvals have continued to exceed completions, resulting in the number of dwellings under construction or yet to be completed reaching historically high levels,” the RBA said.

“If growth in housing demand does not continue to keep pace with the further large increases in supply already in the pipeline, it could place downward pressure on prices and rents and increase the risk that off-the-plan purchases fail to settle.”

While some analysts have described the property market in cities such as Sydney as a bubble, the RBA’s latest comments underscored the central bank’s confidence that cheaper debt would not stoke property prices.

Indeed, it argued that the established housing market was facing “weaker conditions”, as supply came to market in the largest states of NSW, Victoria and Queensland in coming years and vendors take longer to offload properties.

The RBA also dismissed the monthly CoreLogic RP Data series that showed strong house price growth in April and May in many cities, saying a 5 per cent jump in the June quarter was due to methodological changes.

“The most recent data suggest that housing prices declined in most capital cities in July,” the RBA claimed.

The risk of the housing market weakening “substantially” was singled out as a “key uncertainty” to the RBA’s forecasts, which were unchanged: that the economy would grow about 3 per cent next year.

National Australia Bank economist Ivan Colhoun said the RBA’s concern about “downside risks” to the economy, such as the property market, was the more “striking” element of the update, suggesting more official rate cuts may be on the cards.

“From an Australian economic transition perspective, reliance on housing construction to offset mining softness can only last for so long before apartment oversupply issues emerge in all major cities across the east coast,” said Morgans analyst Azib Khan in a recent note exploring the banks’ exposure to the issue.

Commonwealth Bank, the nation’s biggest, will this week provide investors an update on bad debts at its full-year results, with Morgans yesterday upping its second-half impairment charge 10 per cent to $797 million.

While noting pain in the Perth property market, the RBA said greater supply in inner-city Melbourne and Brisbane — areas that have worried analysts

— had to date “largely been absorbed by population growth”.

But the RBA cautioned downward pressure on prices from heavy apartment building in these cities “could increase the risk of off-the-plan purchases failing to settle”.

Greater supply of apartments would also “constrain growth in housing prices and rents”.

Home building had been a key growth engine for the economy and bank profits in recent years as new residential completions grew to around 190,000 last year — up 20 per cent on a decade ago — driven by apartments, the RBA said.

Starts will grow to 217,000 this year before falling to 190,000 next year and correcting in 2018 as apartment approvals dry up, according to UBS.

But fears of settlement failures have grabbed the attention of regulators in the past year, leading banks to limit loans to developers, apartment buyers and offshore buyers.

Like the RBA, the banking regulator, the Australian Prudential Regulation Authority, has been quietly “dialling up” the pressure on banks’ commercial real estate lending after double-digit loan growth across the industry.

Total bank commercial real estate lending has accelerated in the past three years, pushing exposures up 10 per cent in the year to March to $214 billion.

But in a recent report, Mr Khan calculated the major banks only lent apartment developers 53 per cent of the sale price of an apartment.