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Melbourne’s Fragile Property Market Fundamentals

Melbourne’s Fragile Property Market Fundamentals
May 19, 2021 Propertyology Head of Research and REIA Hall of Famer, Simon Pressley

Within just 3-months to the end of April 2021, Melbourne’s median house price increased by 6.5 percent to sit at $869,676. In Propertyology’s opinion, the buzzing activity at open homes and auctions currently observed at the coalface is little more than a smokescreen for Melbourne’s fragile property market fundamentals.

Those with an interest in Melbourne’s property market would be wise to stand back from today’s metrics-of-the-moment and objectively assess the underlying fundamentals.

The rising tides that are lifting all ships at the moment is the powerful combination of record low interest rates and an unprecedented low volume of properties listed for sale (Australia-wide).

But when we scratch below the surface, Melbourne has among the weakest outlook in Australia. A series of leading indicators gives Propertyology cause for some concern about Melbourne’s real estate.

The fragile fundamentals are such that Propertyology cannot rule out the possibility of declines in Melbourne house prices over the coming two years, particularly if APRA intervened and tightened credit policy (although we are vehemently opposed to any such action).

And the prospect of any meaningful capital growth on apartments is totally buggered!

Housing supply excess

While there is a widespread rental crisis all over Australia, Melbourne currently has an all-time record high volume of rental supply.

Melbourne’s residential vacancy rate increased from 1.9 percent directly before the onset of COVID-19 to currently sit at a whopping 4 percent.

The volume of dwellings advertised for rent has increased from 11,091 in March 2020 to 25,050 – that is enough to supply an entire city the size of Launceston or Shepparton.

Understandably, a lot has already been reported about 1 in 12 CBD apartments still sitting empty.

But there has also been a softening in rents for suburban houses, particularly in Melbourne’s inner-east and north-west (in both cases, advertised rents for 3-bedroom houses have declined by $40 per week, or $2,000 annually).

And the Victorian state government has just announced a series of new property taxes in attempt to raise additional revenue because Victoria has borrowed much more than any other state for its economic recovery strategy.

Logic would suggest that such a high volume of landlords with an asset that is now bringing in significantly less income (or none at all) will progressively result in decisions to offload assets, thereby increasing resale supply.

The 40,958 dwellings listed for sale on 30 April 2021 was already 18.9 percent higher than 12-months ago and a significantly bigger supply increase than any other capital city [source: SQM Research].

Propertyology anticipates that the tide will recede in Melbourne with further increases in resale supply throughout 2021. And some of the pent-up demand that everyone has observed over the last 6-months will also ease.

Housing demand is dangerously delicate

Late last year, in response to Melbourne being forced into the world’s tightest lockdown, we instantly became concerned for what it may do to real estate and outlined our concerns in a report exclusively for Propertyology clients.

The single most sustainable driver of housing demand for any property market is a healthy local economy. That’s because buyer behaviour is heavily influenced by confidence in household income security, pressure within the labour market and whether conditions are encouraging people to move to (or away) from a chosen location.

Let us not forget that it was Melbourne’s soft economy that produced a 7.5 percent decline in its median house price over the 2-years ending August 2012.

The current record amount of economic stimulus from a variety of state and federal government packages has resulted in the national economy being stronger today than before COVID-19. But all of Melbourne’s metrics in the above graphic are inferior to elsewhere.

  • Relative to the rest of Australia, the total volume of jobs in Melbourne in March 2021 compared to 2-years earlier is underwhelming. And the change in the volume of new jobs advertised in April 2021 (a leading economic indicator) is well down on the rest of Australia.
  • Between domestic and overseas visitors, Melbourne’s economy used to play host to 11 million visitors that spent $10 billion annually. Unfortunately, the international border closure, combined with domestic concern associated with travelling to densely populated cities, will create pain for the economy of this great global city for some years yet.
  • Pre-COVID-19, 200,000 international students were living in Victoria, each of them requiring long-term rental accommodation and spending circa $50,000 per annum in the local economy – not now!
  • Melbourne CBD’s office occupancy rate of 40 percent is miles lower than every other capital city.
  • Without the tourists, students and office workers frequenting Melbourne’s inner-city for months on end, there are tens of thousands of retail and service industry businesses battling to survive.
  • The comparison of Victoria’s retail trade revenue to other states in the below graphic is stark.

The big whammy

The 70,000 to 80,000 overseas migrants that normally add to Melbourne’s annual housing demand ceased in March 2020. The latest ABS data shows that Victoria produced negative net overseas migration of 20,617 over just 6-months to September 2020, and there is still no sign of the population ‘front door’ re-opening any time soon.

While Melbourne was in its 4-month lockdown, Propertyology flagged the possibility of 30,000 (net) residents leaving Melbourne over 2-years via the ‘back door’. Today’s data confirms that 26,000 have already left in just 12-months.

From overseas and internal migration, Melbourne’s population has effectively declined over the last 12-months.

The early impact of Melbourne’s tight lockdown reminds us of what happened in Perth in 2014 when commodity prices tanked, inflicting several years of pain. Both events marked the beginning of a sharp reversal in migration patterns.

The diminished housing demand is one thing, but the billions of lost revenue from those who left town, going on to spend their household budget elsewhere has just as much impact on the city’s property market.

Perth’s property market trough lasted 6-years and property values have only recently returned to where they were 10-years ago.

The final piece to Melbourne’s property market fundamentals is the construction sector, which has always been integral to this big city’s economy.

Melbourne’s pre-COVID housing supply pipeline was already running at circa 45,000 extra dwellings per year. Part of the Andrew’s state government economic recovery plan is to stimulate the construction sector.

Stimulating this sector at a time when population is effectively declining and several other economic factors are fragile is not a recipe for property price growth.

It is not that long ago that Melbourne (and Sydney) suffered a property market downturn caused by an overzealous construction sector. Melbourne’s median house price declined by $134,000 between January 2018 and May 2019.

Where to from here?

The international border closure was always going to hurt Melbourne (and Sydney) more than any other Australian location. The damage caused by the 4-month tight lockdown may linger for a decade or more.

At an individual city level, the two biggest influences on a property market have always been the performance of its economy and the volume of new housing construction.

The tax increases announced in this month’s State Budget is a sign of what lies ahead for Victoria. Sky-high state government debt places long-term restrictions on funding for infrastructure and industry support, thereby suppressing economic growth and property markets with it. Just look at Queensland’s performance over the last decade.

Melbourne’s weak economy, declining population, record high rental supply, and ratchetting up new housing construction are a collective group of fundamentals that are as weak as what Darwin and Perth saw throughout the last decade.

The current pressure in Melbourne’s property market is already less intense than most of Australia. I anticipate that it will ease as resale listing volumes continue to trend higher from Q2 2021 onwards.

Fortunately, the really low interest rates will provide an important cushion.

All things being equal, I believe detached house prices in Melbourne’s inner and middle ring suburbs are likely to hold reasonably firm for the foreseeable future, but one could not rule out the possibility of a decline in asset values, particularly if APRA decided to flex their muscle.

  • Owner-occupiers: current fundamentals may not be of great importance to you, especially if you plan on staying put for the long-term or are trading one home for another in the same market.
  • Apartments: there is undeniable proof that this asset class was already extremely problematic well before the arrival of the germ – now it is stuffed!
  • Existing landlords: the current soft rental market will hang around for a while. Investors in Melbourne would be wise to review their current position with the likelihood that it will be some years before rents increase.
  • Active investors: the savviest property investors always have a ‘borderless’ mindset. Right now, Australia has a plethora of locations that have a healthy local economic outlook and low risk of future over-supply; Melbourne is not one of them.
  • Commercial office and inner-city retail: I hope existing landlords in this asset class have a secure tenant. The outlook is ugly!

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