(Bloomberg) -- Australia’s commercial property sector will be one of the frontline financial stability risks in the event the nation’s economy deteriorates substantially, the Reserve Bank said.

Falling valuations, weak demand for offices and rising borrowing costs are already combining to pressure the commercial property market, potentially exposing banks that have lent to the sector. 

Australian banks have about 6% of total assets in commercial property, the RBA said in its semi-annual Financial Stability Review released Thursday. Global real estate investment trust valuations have slumped by between 30% and 50% since their peak in early 2022, it said.

RBA Says Banks Are Strong, Households Resilient to Higher Rates

Changed conditions since the pandemic such as flexible work arrangements and online shopping have put pressure on office and retail property prices, the RBA said. Listed real estate investment trusts directly own around 10% of office space and 60% of retail properties in Australia.

At present, Australian real estate investment trusts have strong balance sheets and can withstand a fall in rental income, the RBA said. They are not highly geared, although their “leverage will increase if declining valuations lead to mark downs of the book value of their properties,” it said.

“If rental income were to fall sharply in an economic downturn, some landlords are likely to become financially distressed,” the central bank said. 

Commercial property investors who borrow in international capital markets may also have difficulty refinancing expiring loans as lenders turn more cautious following the banking turmoil, it said.

The RBA is among central banks worldwide that are monitoring the commercial property sector after the collapse of banks in the US and bailouts in Europe exposed liquidity issues in some assets. 

ECB Warns of Risks Posed by €1 Trillion Real Estate Funds

The European Central Bank, which raised interest rates by a half-point in March, has highlighted real estate investment funds as a stability risk.

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