Melbourne Residential Market Report - June 2015

Australian Property Institute - Opteon Property Group report


Melbourne market remains healthy amid national talk of boom or bust

Melbourne’s fascination with the property market is a sport. The talk around the water cooler at the moment is continually based around the state of the market. Is the market booming or about to crash? Is there a housing bubble that is set to burst? To answer this we have looked at the fundamentals and looked back to past to find cues that can be compared to today.

All markets move in cycles of up times, down times and in-between (or average) times. So when we use the terms “bust” or“crash” we should stipulate we are referring to a significant market downturn where base line values are completely shifted. All market downturns occur when demand falls away dramatically. A crash occurs when sellers need to create demand to lower their price to meet the market -a reverse auction in effect.

When we look back at 2008 and the Global Financial Crisis (GFC) there was a dramatic reduction in demand and buyer activity in second half of 2008. However the Melbourne values only reduced relatively marginally. Why? Because sellers did not need to meet the market (holistically) as interest rates reduced in a short period of time and Federal Governments stimulus package (well placed or not) worked to pump up the economy.

Now compare this to 1990 when the economy crashed (remember “the recession we had to have”), sellers could not take option of holding, interest rates had hit 17% coupled with housing values that increased 83% over five years, an average compounding increase of 13% per year.

What about our current market? The median value of houses is $688,000 (as at March quarter 2015) which reflects a 32% increase of the 2010 median of $420,000, an average compounding increase of 5.8% per year. On these numbers values don’t seem to be escalating out of control, although the last 12 months has seen a 10% increase, and higher in the inner suburbs. This is above the 30 year average of 7.6% average increase per annum.

So on what we know a housing “boom” or “bust” both occur when the balance between demand and supply is significantly tilted. When demand is significantly higher than supply we are in “boom” conditions where values are likely to increase sharply. When demand is significantly lower than motivated supply (i.e. vendors who need to meet the market) then there a backdrop for Crash.

What drives the market?

  • Demand and supply
  • Demand influenced by location, confidence, affordability (finance), incentives (fhobg), population growth/decline, economic conditions
  • Supply influenced by available land, property development (units, apartments etc), government (zoning, Urban Growth Boundary), confidence

What creates a boom?

  • Excess of demand over supply
  • Demand excess can occur due to population growth; buoyant economic conditions; affordability; buyer sentiment; market trends (area specific)
  • Supply deficiency can occur due insufficient new land available; lack of physical supply (i.e. low number of properties in a given area)

Bust times occur when?

  • Supply exceeds demand
  • Excess properties are offered to the market due to economic conditions (loss of employment); financial reasons (owners cannot afford to keep paying the mortgage); over development of property (as occurred in many parts of the USA and Spain)

Melbourne’s current conditions

Supply

  • Overall there is a constrained supply to Melbourne’s property supply. However, there are differing levels of supply across different residential property types.
  • Existing dwellings tend to have greater demand than supply. In general the closer to the middle (Melbourne CBD) the more supply is constrained.
  • New land, apart from infill developments, is restricted to the growth corridors within the Urban Growth Boundary. This supply of available land in these corridors is expected to generally balanced between supply and demand albeit there are likely to be times of greater supply than demand which will limit the value increase in land prices in these areas.

Demand

Days on market is a good indicator of the depth of the market and the completion from buyers to secure a property. As a general rule the longer the days on market the greater pressure there is on sellers to reduce their price expectation.  The below graph shows 44 days for Melbourne Metro as at February 2015. Anecdotally this is around the long run average, however it has trended upwards from a low point of just over 30 days in Feb 2014. This indicates that there may not be the same upwards rise in values there has been in the past two years. (Although this does not account for area specific demand. Low supply locations may still rise out of trend with the market as a whole.)


Investors are the story of this current upsurge in buyer activity. The next graph demonstrates that investors are currently purchasing just under $150 billion in residential real estate, almost double their spend in 2011. Upgradershave also been more active in the market whereas first home buyers have remained steady.

Victoria’s net migration (with the majority occurring in Melbourne metro) is steadily increasing year on year. The majority of the net increase (89% for financial year ending 2014) is from overseas migration (NOM) although it is worth noting that net interstate migration to Victoria is steadily increasing.
 

Overseas investors, with a particular emphasis on China and Singapore, have become a dominant feature in the Melbourne property market. We’ve discussed Melbourne’s insatiable love of property, andperhaps this is matched or even amplified by Chinese and Singaporean investors.

We hear anecdotal stories that these buyers are generally looking to invest in Australia as a “bolt hole” or safe haven from their local capital markets. It is difficult to accurately analyse however as we understand a typical Chinese investor in Melbourne residential property is buying with a low loan to value ratio (LVR). We further understand this buyer typically does not buy chasing rental yields. The growth of this property buyer seems to be fuelling the Melbourne apartment market. The next two years could potentially see all-time high numbers of new or off the plan apartment towers being offered to the market. Developers and agents are targeting the rich overseas source of buyers who anecdotally are not as price-sensitive as local buyers. Putting aside loopholes, overseas investors are only permitted to invest in new property. A problem for this sector is the potential to create a two tiered market whereby overseas investors are prepared to pay a higher price for new and off the plan apartments compared to local buyers buying second hand stock. This could compromise the market stability in this sector if large numbers of apartments come back onto the market (second hand stock) or investment buyers from overseas dry up. 

There seems to be a general consensus (or school of thought) that a typical Chinese investor buyer will have a “set and forget” strategy, or in other words has a long term view to buying in Australia and given the lower LVR is not as sensitive to economic ups and downs with the ability ride out short term economic instability. The increased supply of apartments to investors has the potential to put downward pressure on apartments rents in the short- to medium-term.

Sentiment

Consumer sentimenthas been below neutral for the last 12 months. Victorian property sentiment is above neutral but trending down.


The national unemployment rate has been steadily increasing since approximately 2010. Victoria’s unemployment rate has fallen over the past 12 months from 6.3% to 6% (as at February 20015, ABS, RBA).

Financial

There is a strong relationship between changes in RBA cash rate and sales volumes. If we look at the graph below, and then compare blue line that represents annual percentage growth of median house values to standard home loan rates (sourced from the RBA) we can see that every time in the past 25 years where there is negative growth to the median house value it corresponds with an increase in the standard variable home loan rate in the preceding period. This demonstrates the direct relationship between interest rates and housing values.

Affordability

A common factor between market crashes is it occurs at a time when affordability of housing become unsustainable for the average buyer.

The graph below represents the relationship between average earnings and the costs of servicing a mortgage based on borrowing 70% of the median house value. The blue line represents the percentage of income required to meet the mortgage. The graph is measured in five year blocks and starts in 1990 where under these parameters affordability was at its worst with over 50% of an average weekly male wage was required to service a loan. The low point was around 1995 where the percentage fell to 30% and then steadily increased to around 2010 where the percentage hit 44% before falling to its current level of 41%. The 25 year trend sits around 39% which on the face of indicate that current relationship between median value, wages and interest rates is delicately balanced with an emphasis on marginally unaffordable. Upward changes to interest rates and median values without corresponding increases to wages would exacerbate this.

 

Conclusion

Melbourne’s housing market remains strong at present due in the main to constrained supply, net migration increases, an upsurge in activity from investors and a low interest/relatively open supply of credit availability.

Housing un-affordability is over the longer term trend but not significantly so. In a general sense natural forces would suggest that real increases to the median value will not increase beyond wage growth and or reduction in interest rates. The caveat to this is overseas investment which in many senses is ambivalent to local wage growth and affordability. Further pressure from overseas investors competing with local buyers may affect the local markets ability to compete without increasing the affordability of local buyers. This is particularly so in the new apartment and unit sectors that are dominated by overseas investors.

A property crash can normally be associated with an unforeseen event (i.e. GFC) significantly affecting supply and demand. Like a perfect storm the event hits when a market is at a peak. The Melbourne market is at a high although prices (unlike Sydney) have not been growing at what would seem as unsustainably high rates. Markets are cyclical in nature with times of ups, downs and sideways movements. The Melbourne market may be moving to a time sideways movement or potential some sectors contracting. This is typical and should not be viewed as markets crashing.  From a medium to longer term perspective the fundamentals of the Melbourne property market seem sound, there is a growing population that requires housing, constrained housing supply (through planning restrictions) that is not likely to result in an oversupply (over the medium to long run) and a local economy that is fundamentally sound.  Markets are never perfect and will have times (and sectors) where they get ahead of themselves or even lag behind. Over a medium term the market corrects these imbalances.  Our view is that whilst it is likely median values may not increase at high rates then baring any foreseen event the property market is not likely to crash.