Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 164

For sale: cheaper apartments

Governments and banks have reacted to concerns over the east coast housing boom by instigating cooling measures. Tighter loan criteria, additional stamp duties, and the election debate over negative gearing are all designed to slow prices. However, as the charts below show, there’s no need to do anything: the east coast market is about to be swamped with apartments.

The UBS economics team believes there should be a moderation rather than a downturn, as the tailwinds from record low interest rates offset the headwinds of tighter banking criteria and higher taxes. What is most concerning though, is the impending supply of apartment stock.

Record unit approvals

Last year I wrote about the record number of unit approvals along the east coast, with particular concerns about the expected levels of supply in Melbourne and Brisbane. Roll forward to June 2016 and most of those approvals have turned into commencements, with around 137,000 medium density dwellings now under construction. This is about four times more than was under construction in 2000, with 88% of the national total in NSW, Victoria and Queensland. The spike in multi-storey apartments can clearly be seen below, while housing is within historical ranges.

Chart 1: Dwellings under construction in Australia

PatBarret1

PatBarret1

In absolute number terms, it's startling. Construction of apartments in Queensland is running at five times its levels from the year 2000, while NSW and Victoria each represent over 30% of all supply.

At the project level, supply in Queensland and Victoria is largely centred around CBDs, while NSW supply is dispersed across metropolitan areas, spreading the risk. With this supply largely hitting the market in the next year, will those who paid a 10% deposit be able to finance the settlement of the remaining 90%? As a rule of thumb, we estimate that about 70% of purchasers are local buyers (owner occupiers and investors), while about 30% are connected to foreign buyers.

Table 1: Dwellings under construction by type and state as at Dec 2000 and Dec 2015

 PatBarret2

 

PatBarret3

Settlement risk

The key question is whether it’s in the purchaser’s best interest to settle and that will largely depend on price movements between the dates of the deposit payment (probably 10%) and settlement.

Using Lend Lease as a guide, it appears that anyone who bought an apartment in Sydney is ‘in the money’ and would forego strong capital gains if they walked away from the purchase. Developments such as Melbourne’s Collins Street and Brisbane’s The Yards are less conducive to gains, as shown in the chart below. While a profitable re-sale in Sydney seems highly probable, it seems less so in Melbourne and more difficult in Brisbane. Interestingly, Lend Lease’s highest default rate during the GFC was 3%, versus less than 1% at present. I must point out that the listed market developers like Lend Lease and Mirvac produce higher-quality units that would be more desirable in a re-sale market than some peers.

Lend Lease

Financing switching from banks to mezzanine lenders

The great thing about a turning point in the cycle is that those with strong balance sheets and solid cashflows can take advantage of other groups’ weaknesses. I recently spoke to three mezzanine loan providers who said they’d never been busier. When the banks close the doors, other providers step forward and are happy to help, but it will cost more. All three have existing loans to residential developers with solid credentials who were refused construction finance from the big four banks. Two of these were working on plans to raise capital to ‘mop up’ developers who struggle. Those with strong balance sheets and cash resources such as Mirvac, Lend Lease and Stockland will increase their market share in the next two years.

The oversupply should lead to falling apartment rentals as investors compete to secure income. This will take the apartment yield (net of costs) to less than 2% or 50x price to earnings. Investors would do well to sit back and wait.

For those who wonder what happens to the traditional house and land site, weakness in apartments should have an impact. When inner city apartment rents decline, those renting on the fringes can upgrade location. Pleasingly, housing supply is not excessive and continues to be hamstrung by council approval processes. Note that the two markets (houses and apartments) are distinct with a large family on a suburban block with kids at the local school unlikely to switch to a CBD unit.

Of course, property investment is not only residential. A relatively high-yielding, liquid investment such as a REIT, with capital growth potential and expert management, should not be discounted. With our expectation of low rates and a healthy yield buffer above cash and bonds, we remain confident that investments in commercial property, in particular REITs, will continue to deliver solid returns.

Pat Barrett is Property Analyst at UBS Asset Management. Nothing in this document is to be taken as specific financial product advice and it does not take into account any individual investor’s investment objectives, tax and financial situation or particular needs.

UBS

RELATED ARTICLES

Steve Bennett on investing in direct property for the long term

Don’t treat bank shares as defensive assets

banner

Most viewed in recent weeks

Noel's share winners and loser plus budget reality check

Among the share success stories is a poor personal experience as Telstra's service needs improving. Plus why the new budget announcements on downsizing and buying a home don't deserve the super hype.

Grantham interview on the coming day of reckoning

Jeremy Grantham has seen it all before, with bubbles every 15 years or so. The higher you go, the longer and greater the fall. You can have a high-priced asset or a high-yielding asset, but not both at the same time.

Five stock recoveries not hanging on COVID predictions

The focus on predicting the recovery from the pandemic is the wrong emphasis. Better to identify great companies benefitting from market changes over a three- to five-year horizon with or without COVID.

BHP v Rio v Fortescue: it's all about the iron ore price

Don’t look at an earnings forecast or a DCF valuation or a broker target price for a mining company. Share price forecasts are only as good as the commodity price assumptions they are based on, and they are a guess.

Blink and you missed a seismic shift in these stocks

Blink and it happened. If announcements in this sector were made by a producer of iron ore, gas, copper or some new tech, the news would have been splashed across the front pages. Have we witnessed a major change?

Peak to peak, which LIC managers performed during COVID?

A comprehensive review of dozens of LICs shows how they performed in the crucial 'peak to peak' of COVID. This 14 months tested the mettle and strategies of a sector often under fire, with many strong results.

Latest Updates

Superannuation

Jane Hume shakes up super, but what will it achieve?

The Government calls 'Your Future, Your Super' the most significant reforms since the start of compulsory super. Stapling has benefits and we should remove poor funds, but performance comparisons are difficult.

Superannuation

Launch of the 'Wealth of Experience' podcast

Welcome to the first episode of our fortnightly podcast, Wealth of Experience, with Graham Hand and Peter Warnes. They have a combined 99 years in markets and they will share this experience to help build your wealth.

Investment strategies

How inflation impacts different types of investments

A comprehensive study of the impact of inflation on returns from different assets over the past 120 years. The high returns in recent years are due to low inflation and falling rates but this ‘sweet spot’ is ending.

Investment strategies

Where will investment returns come from in 2021?

There are only three sources of returns when investing in companies. Whether an investment delivers on dividends, earnings or valuation expansion determines performance, and the contribution of each varies over time.

Investment strategies

Portfolio composition and what you find under the bonnet

Powerful structural themes such as technology disruption and demographic changes may disguise what is driving company success. Watch these broad categories as they may not apply in ways you expect.

Investment strategies

When rates rise, it's time to look for new players on the team

Long duration assets such as government bonds and property have benefitted from falling interest rates, but a turn is coming. It's time to find assets that may benefit from rising rates, such as private debt.

Investment strategies

How are high net worths investing and thinking now?

Citi research delves into how high net worth investors are feeling in the current market, and how they are investing during the drama of the pandemic. There is plenty of optimism and a willingness to stay invested.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.