"While rising housing prices and greater household borrowing are expected results from the monetary easing that has taken place and are helping to support residential building activity, they also have the ability to encourage speculative housing activity," the bank said. "It is important for investors and owner-occupiers to understand that a cyclical upswing in housing prices when interest rates are low cannot continue indefinitely and they should therefore account for this in their purchasing decisions," the RBA said. Factors contributing to risk The RBA cited several factors for the rise in investor home loans such as the reduction in state grants to first-home buyers and the way banks assess loan serviceability that works against first home buyers. It said that an upsurge in speculative housing demand would be more likely to generate financial stability risks if it "brought forth an increase in construction on a scale that led to a future overhang of supply and a subsequent decline in house prices".

Lending to both housing investors and repeat buyer owner occupiers has been increasing for some time in NSW and has also picked up in some other states in the past six months, the bank said. The RBA pointed out that investors now make up 40 per cent of the total value of housing loan approvals, similar to a peak in 2003 while previous peaks are also being approached in Victoria "Strong investor lending may contribute to a build up in risk in banks mortgage portfolios by funding additional speculative demand that increases the chance of a sharp housing market downturn in the future", it said. The RBA said that while lending standards had generally been maintained by Australia banks, as evidenced by consistent LVRs and a low portion of low-documentation loans, there was early evidence of aggressive lending. It said that banks are expanding into new geographies and products and "some evidence of less conservative serviceability assessments when determining the amounts they are willing to lend".

Softening leasing conditions in commercial property The RBA also warned up the rising risks in commercial property as investors chased yield even as rentals weakened. It made reference to "a disconnect" between prices and rents in the CBD office property market that has continued and broadened beyond Sydney and Melbourne. Additional supply and weaker tenant demand meant leasing conditions had softened. Rent incentives had reached their highest levels since the mid-90s while vacancy rates in the CBD continued to rise. Yet the value of property transactions has continued to increase even as rental conditions weakened. The RBA said that the strong investor demand for commercial property has been reportedly driven by attractive yields on Australian property relative to major markets and other domestic investments, and was being driven by offshore investors.

The bank said some of the risks of lack of tenants could be mitigated by transforming commercial properties into residential properties. It added that since banks were reluctant to lend to developers most of the resulting risk of lack of tenants would be borne by developers and their funders. The RBA once again noted rising risk appetite among Australian households as they chased income in a low-yield environment. Previously the bank had cited the demand for hybrid securities but this time it focused on "retail securitisation funds". These funds invest in the lower ranking or mezzanine tranches of mortgage backed securities. In return for higher interest payments that agree to take losses on home loan defaults ahead of other higher ranking investors. "Although the size of these retail securitisation funds is quite small they have grown strongly. It is important that the potential risks associated with these products is adequately communicated to and understood by households" The RBA repeated its warning that bank profits may not be sustainable particularly as demand for loans remained low. Bank lending has grown at a moderate pace of around 6.5 per cent over six months to January 2014 with investment loans growing at a higher 8.5 per cent.

"With banks bad and doubtful debt charges now at relatively low levels and in an environment of moderate credit growth, the sources of profit growth may be more limited in the period ahead." The RBA said that "macroprudential" policies in New Zealand which limited lending to borrowers with small downpayments, had led to a substantial decline in high loan to value mortgages in the system. Loading But it cited reports that banks were competing more aggressively for lower LVR mortgages. "It is unclear what effect the regulatory measures will have on the housing market and banks credit portfolios over the medium term."