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I’m forever blowing bubbles: Has the Sydney apartment market finally burst?

Posted by on March 30th, 2017 · Affordability, Construction, Housing, Housing supply, Sydney

By Bill Randolph, Director, City Futures Research Centre. Originally published in Around the House, newsletter of Shelter NSW.

Much speculation in the property press in recent months has centred on the question of the supposed ‘housing bubble’ (is there one?) and, if so, what is its likely trajectory (will it burst?).  Pundits have vied for position on this, presenting copious charts and tables to divine the truth in the entrails – sceptics denying the very idea of a property bubble while others anticipate its imminent demise.  The impact on property prices – if not affordability – is an over-riding concern.  And its the high-density apartment market that is the focus of most concern particularly central city locations in Brisbane, Melbourne and Sydney.  So has the development industry overshot in its ‘dash for density’, and if so, how far would the market fall?  And will this have an impact on affordability?

That property markets have cycles of boom and bust is hardly news.  It’s the nature of the beast.  In many respects, we should expect there to be a down turn if supply over-reaches demand or economic or political circumstance change to the detriment of profitability.  Successful developers, like successful surfers, have to judge when to get into and out of the property wave – the trick is to judge when to take the drop and then when to bail.

However, in the case of the Australian apartment market, we may be in uncharted waters.  Once upon a time, building and selling homes was pretty straightforward.  You found a field, got a development approval, cleared the cows away, built a line of houses and sold them to local buyers.  The market was susceptible to the vagaries of interest rates, employment trends or policy interventions by government.  But it was a market which responded to local and national demand and supply factors.

The problem is that the contemporary high density apartment market in Australia simply does not work like the old style suburban house market.  The overwhelming impact of investor buying has re-written the rulebook, which means that it is becoming more difficult to spot the obvious movements in demand and supply patterns.  In fact, the apartment market has always been dominated by investors – the strata laws brought in during the early 1960s were explicitly tailored to allow investors to buy single apartments, rather than having to buy a whole block.  But the contemporary apartment market has now entered an altogether different phase.

Why is this?  Well, apartments have become the new Krugerrands – objects of pure speculative desire.  With the yields on competing investments at historic lows, property, and the capital gains that can be made from owning it, has become an accepted form of personal wealth creation.  There is no need to rehearse the debates about why this is – forests have been felled rehashing the argument for and against the current tax and subsidy incentives for investors and the financial circumstances driving their behaviour.  But importantly, this is no longer a solely domestic matter.  The conditions driving investment in rental property are now global, drawing in increasing amounts of money from overseas to take advantage of the spectacular property price values that have become the norm in Australia cities.

But here’s where it gets interesting.  Usually in speculative bubbles, the investment frenzy feeds on itself and then, eventually, something triggers a reverse with an inevitable price correction (think tulips in 17th century Holland).  But the signs of a price reversal in the Sydney apartment market are not altogether evident just yet, despite the record breaking supply levels.  When the Federal Reserve Bank moved to restrict funding to domestic investors and developers in mid-2015, the apartment market paused a little, but then continued apace, at least in the twin epicentres of the market – Sydney and Melbourne. Someone, or something, was pushing it forward.  While evidence as to exactly who/what is responsible is hotly contested, all the data point to the residential investor, especially given the historic low proportion of first homebuyers now entering the market.  Traditional ‘mums and dads’ as well as self-managed pension funds – the Boomers who are stealing their children’s housing – have played their part.   On the other side of the equation, finance for apartment development, once dominated by the big banks, has now become highly fluid, with a wide range of secondary banks and private equity funders now putting money into the sector.

But arguably, the big kicker in recent years has been the rise of the overseas investment.  This has powered the Australian apartment market on both the consumer and the developer sides.  The entry into the Australian housing market by the overseas development sector seeking more stable conditions to undertake their business, supported by a relaxed foreign investment policies and our increasingly permissive planning framework, is a new addition to our housing market.  They come already cashed up and with access to substantial funds able to outbid even local developers.  This further bids up land values and final costs.  While the Chinese government has moved to control the transfer of funds overseas for property speculation, this is a growing source of new funding on the development side.  One recent estimate puts Chinese companies buying 75% of all development sites in Melbourne in the last half of 2016.  But the Chinese are joined by a roster of other nationalities – Malaysia, Singapore and others – all cashing in on our property markets.

On the demand side, the imposition of higher stamp duties and other restrictions on overseas buyers may have lessened the immediate appeal of Australian property, but there are few signs yet that this demand is faltering.  With foreign buyers accounting for 11 percent all homes purchased in NSW between July and September last year, the majority from Asia and the sub-continent , this is clearly a very active market.  In the process, they raised $115 million in stamp duty.  With this kind of pay-off, there is little reason to believe State Treasuries will want to turn off this particular revenue tap too quickly.  And with Alibaba, the Chinese owned global e-commerce platform, now talking about marketing Australian apartments, there is likely to be no let-up in the pressure from this quarter.  There is little doubt, however, that demand from investors from all directions – home and abroad – is at an unprecedented high in the Sydney apartment market.  By the 4th quarter 2016, NSW alone accounted for half of all national investor finance for housing consumption, the vast majority focused on Sydney.

Everyone, it seems, wants a slice of the action.  The extent to which this market is also driven by ‘hot’ money – property is as good, if not better, a way of laundering illicit money than gambling – is, of course another matter.  Interestingly, the Mayor of London, Sadiq Khan, has just announced a major enquiry into the foreign speculative apartment market in London in order to get to the bottom of where all this money is coming from.  But this will be a difficult task.  With multiple global influences, the financial flows coming into our apartment market are becoming too complex to be easily identified, shielded by convoluted company structures and off-shore tax havens.  No one can be entirely sure where the money is coming from.

So is there an oversupply of apartments in Sydney?  Probably not, so long as off-the-plan overseas investors sales can be maintained, although what contribution these are making to meet domestic housing demand is another matter.  As for local investors, the data suggest the party is still in full swing (Figure 2).  While investor lending dipped for existing property after the Reserve Bank tightened controls in mid-2015, lending for new build powered ahead.

Figure 1: Lending for Rental Properties – NSW

Source:  Source: HIA Residential Construction Outlook – NSW (2017). 

But there are signs the market itself is starting to pull back from the brink.  Latest data from the Housing Industry Association suggest we are approaching peak supply of apartments in NSW (Figure 2).  Why there will be a downturn is difficult to say, given the continued strength of the investment market.  Capacity issues may be part of the answer – just how many flats can the Sydney housing industry build when output is already at an all-time high?  There may well be a shortage of sites – unless major releases are about to happen on the fringe or the large renewal areas.  But then there’s the age-old way the development industry carefully manages the development of their land banks or sites on which they have development options to better control prices.  Or the figures could reflect the need for the industry to make out that supply will fall off in order to maintain pressure on government not to act on the tax and other arrangements that have created the boom in the first place.

Figure 2: NSW Housing Starts Forecast to 2018/19

Source: HIA Residential Construction Outlook – NSW(2017). 

Given the almost complete disregard that property prices have paid to housing supply trends in the recent past (see Figure 3), there is no easy way to predict the outcome of a falling apartment supply pipeline in this market.  Perhaps the least likely outcome is a widespread return for more affordable homes – the market simply does not seem to have a capacity to do this on current settings.

Figure 3: House prices (RHS) and dwelling completions (LHS), Greater Sydney 1991 – 2015

Source:  Inga Ting, SMH 5 Sept 2016.

So, has the Sydney apartment boom – or bubble – about to burst?  The Australian housing market has been almost alone among comparable economies in not witnessing a major residential property price correction over the last twenty years.  But given historically high – and some say unsustainable – personal debt levels and an unquestionably unaffordable housing market that is eating away at domestic demand, can the investors keep the party going?  After you with the crystal ball!

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