Mad Melbourne

By Leith van Onselen

What’s wrong with the below story?

1. Melbourne home sales have tanked, tracking -42% below the five-year average and -36% lower than last year’s sales activity:

2. Mortgage demand in Victoria has collapsed, with the number of mortgage discharges (mortgages repaid in-full) actually exceeding the number of mortgage lodgements (new mortgages) in the year to June 2012:

3. The number of homes for sale in Melbourne is at record highs, tracking around double 2008 levels:

4. New house sales in Victoria are anemic and expected to decline further now that the $13,000 First Home Bonus (which was available to newly constructed homes) has expired:

5. And yet new home construction continues in ernest, with Victoria completing nearly 40% of the nation’s new dwellings in the March quarter of 2012 – a record share – and more construction in the pipeline:

Twitter: Leith van Onselen. Leith is the Chief Economist of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.

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  1. I rent in Melbourne. It’s been funny over the past year to see national real estate affiliated spokespeople merge from ‘It’ll be fine’ to ‘It’ll be okay where you are, unless you live in Melbourne’.

    Any insight into why Melbourne’ building activity is so different from the other states? What were these people thinking when they started building? Victorian boomer investors who prefer what they know? Dumb money chasing 2009/2010 returns? Opportunistic developers? Foreign demand?

    • It’s been funny over the past year to see national real estate affiliated spokespeople merge from ‘It’ll be fine’ to ‘It’ll be okay where you are, unless you live in Melbourne’.

      Soon it will turn into: It’ll be fine maaaateeee, as long as you live in the suburb x, y, z.

      • yes, generally it starts as:
        1) property never drops
        2) residential property never drops
        3) Australian property never drops
        3) only apartments drop
        4) only houses in bad areas / cities drop
        5) houses in great areas / cities never drop
        6) houses have dropped a bit everywhere, its a great time to buy a bargain
        7) houses have crashed, its a great time to buy a bargain
        8) houses are 50% below their levels from 10 years ago, great time to buy a bargain
        Of the above I’d be prepared to conceed that by 7) and 8)the spruiker is getting quite close to the truth, as long as you accept there is still risk attached, and nothing is EVER a sure thing.

    • What were these people thinking when they started building?

      That is the problem when you start believing in your own lies/propaganda – HIA and the builders lobby spread the word that there is a “shortage” of houses. And they started believing it themselves.

    • So Melb is not so different to the rest of the world?

      Thank goodness Sydney is still different 🙂

      • MsSolarFelineAU

        “Thank goodness Sydney is still different 🙂 ”

        Of COURSE Sydney is different!! Bhahaha! Sydney is the CENTER of the Australian-Universe!

        This crash hasn’t happened to you Sydney people. And, when it inevitably does, it will be BLOODY.

    • russellsmith55

      Mitch suggested here that many of the new starts are being funded by union superannuation money to keep workers employed, and I think this probably makes sense (would be nice if I knew a way to confirm this somehow).

      Seems like a choice between letting it crash and watching the industry die for a few years, or keeping only a very small number of people employed and preventing the resurrection for many more.

    • StanGoodvibes

      I saw a documentary a couple of years back on like 60 minutes or something; some Kiwi guy from small-town NZ (think Cessnock) came over to Oz in the mid-90’s and him and a mate did up a house between them and made $13k on the deal.

      Cut to 2010 and the guy has a building company knocking up McMansions on Melbourne fringe farmland and is worth $60 million (bastard! LOL).

      The telling part was at the end when the interviewer asked him how far he thought he could go and he was intimating that being a billionaire wasn’t out of the question.

      I suspect he’s still knocking up houses as fast as he can. Hopefully he’ll crash and burn and I can feel better about not doing the same thing myself 🙂

    • > What were these people thinking when they started building?

      Haven’t you heard about contrary investing? 🙂

  2. Leith, given the above, any insight on why melbourne prices have been up significantly since mid june according to rpdatas daily index?

    • 1. The index is unproven. It more likely to be lagging that it looks.
      2. Significantly?
      3. Trend is what matters, it is unaltered.
      4. Realty is illiquid. Takes time to move. Melbourne could up for quite some time without disrupting primary down trend.

      • “The index is unproven”

        Which is what i’m trying to determine. Is this index worth anything more than entertainment value?

        I would say that is a significant change though.

        12th June: 567.37
        Today: 587.47
        Which is a 3.36% increase in just over a month.

    • The RPData index might provide meaningful long term information, but in the short run it’s either capturing major changes in the property market, or is prone to statistical noise.

      Consider the last couple of months of results for Melbourne:

      Overall -2.7% (30% annually?)
      Houses -2.8%
      Units -1.4%

      Overall +1%
      Houses +1.35%
      Units -1.36%

      Maybe the market has actually developed this way, and there has been an increase in prices after a severe dip. However, I’m not inclined to believe that is true. To me this appears to be reversion to the mean, or some temporary impact of first home buyers moving into below-average housing that isn’t filtered out by their algorithms.

      • Could just be the sample size.

        Bigger and more valuable properties may have been sold in June than in May.

        Wait to see the quarterly results and look at the big trend.

  3. I see a property price crash.

    Nothing wrong with that at all!!

    Its gonna be a good one too.

  4. Leith,

    Could you explain the difference between the “Dwelling Completions by State” graph you published yesterday and the one above?

    It appears to be on the vertical axis (raw number v % of total construction). Do you have a preferred measure? If so, why?

  5. Hi Leith,
    Is the monthly volume of sales available from a free source? Or is it subscription only?

  6. I’ve been trying to figure that one out as well. I have come down to:

    1. Corporate momentum – when companies have the money they spend it until the end (that is what the employees are paid to do). So the things that started go until they hit the wall.

    2. Melbourne does seem to have a dogmatic view of property as a long term investment so this might be hard to shake initially.

    3. Foreign investment – Melb has a great Chinese community so off the plan demand might still be coming?

    But it doesn’t look good. Do a search for units for sale in the 10km melb zone and the results are just staggering.

  7. Its the reason why property is falling that construction is still going. Melbourne does not have a supply problem at all. The truth is though this makes it a better place to live. Property is a consumer good in the end for someone after all (only an investment if you get paid to let someone else consume your good).

    Sydney is almost the inverse of this situation. Low construction, high land prices, and heavy restrictions on land release.

  8. I assume dwellings include apartments.

    We must understand that there is probably at least a two year, and in larger projects probably 3+ year, lag from the off-the-plan purchase decision to completion when that new stock hits the market, an the completion statistics.

    There are still numerous large apartment projects in construction phase. The CBD and Southbank precincts will have several thousand new apartments completed over the next 12 – 24 months. Changes in sentiment therefore take a long period of time to show up in the statistics being analysed above.

    Most of these apartments have been pre-sold, otherwise the projects wouldn’t receive support from senior debt financiers (and mezzanine debt investors who are regular participants in the financing of residential development in Melbourne). At a minimum this would represent 75%-80% of the stock in the building.

    The following list, in my view, are worthy of greater discussion and consideration when analysing the Melbourne market in particular:

    1. Already word on the street is that in some instances valuations on recently completed apartments are not supporting their purchase prices. As a consequence, some vendor financing is taking place in order to facilitate settlements. It seems banks believe the apartment price point ceiling has been reached in Melbourne.

    2. As we know, rental yields in Melbourne are terrible. This situation will not improve as more stock is offered to the market. Clearly these investors are expecting to fully utilise depreciation allowances to gross up their after tax returns and then rely on capital growth expectations to generate a return on their investment. Time will be the judge of the wisdom of this assumption. The euphoria generated from the FHOG boost in 2009-10 when many apartment contracts were signed should not be forgotten. However, an assumption that may have been somewhat supportable 2-3 years ago given the real estate mania at the time now seems unlikely to play out. How many new apartments will immediately hit the market for resale is a question on my mind.

    3. Asian developers are particularly active in Melbourne. Look up SP Setia, Chip CEng Eng/CEL as a starting point who are undertaking very large projects. In many cases sales are made to investors in their own countries and in the permanent resident local Asian communities (perhaps as nominees for associates in their home countries?). How much of this investment is driven by a desire to move funds offshore, out of China in particular, is hard to say. Until we can count the number of empty apartments that are outside the rental market in a couple of years we will not know the true extent of that.

    4. Design of Melbourne apartments has been a race to the bottom for a number of years. A large proportion of new inner city one and two bedroom units have bedrooms with no natural light, and therefore, no ventilation. These are proving challenging to lease as, unsurprisingly, tenants are finding such living conditions to be sub standard. Another issue for investors to face when trying to generate yield from their dwelling investments.

    5. Developers are price takers especially when it comes to construction costs. Floor space efficiency in apartment buildings has now been maxed out, and finishing standards can’t drop much lower. To produce apartments at more affordable levels, and assuming concrete and steel prices remain constant, the labour component of construction costs must reduce. If Melbourne’s current construction cycle begins to taper off in the next 12 – 24 months it will be interesting to see whether we see any construction industry wage deflation – difficult in a heavily unionised environment – but perhaps necessary for activity levels to remain. The other major input is clearly land values, with the revenue side maxed out, demand softening and sticky construction costs remaining landowners who must sell will be the first to be squeezed in this market.

    • With the pre-sales, my limited understanding is that people have put down 10% cash deposit/deposit bond, so what about the risk of settlement escape at completion due to lower prices (~10% down from peak in Melbourne) or even inability to get finance due to lower valuations, etc?

      • Yes, 10% is the deposit in most cases and is the maximum allowed in the case of off the plan sales in Victoria.

        A reduction in value will not enable a purchaser to rescind a contract. Notwithstanding this, falling values/valuations are likely to encourage some purchasers to seek avenues to escape from their contracts for other reasons. The ability to do so will usually depend on the competence of the developer’s lawyers and others involved in the contract preparation/exchange process. If the contracts have been properly prepared and executed and are up to date with legislative changes, it’s very difficult to get out of an off the plan contract.

        Inability to obtain finance is the big risk, particularly for the equity and mezzanine participants in the capital stack. I expect to see more vendor financing utilised in Melbourne in order to get settlements across the line. Very dilutive to a developer’s return if he has insufficient funds to repay his mezzanine debt financiers immediately after completion of construction.

        If a purchaser fails to settle and forfeits their deposit the developer can pursue them for any shortfall crystallised in the subsequent sale of the apartment. A manageable task if the purchaser is a local and solvent, somewhat more difficult if they are located overseas.

        • See the last 2-3years on the GC as an example of what to look forward to..
          Laws have been recently amended in Qld to make these off-the-plan contracts more difficult to escape, as the purchasers started heading for the exits.

        • The Patrician

          “If a purchaser fails to settle and forfeits their deposit the developer can pursue them for any shortfall crystallised in the subsequent sale of the apartment. A manageable task if the purchaser is a local and solvent, somewhat more difficult if they are located overseas.”

          Wow! the above telling observation must send shivers down the spine of every over-leveraged developer…(and their bankers)

    • Thanks Washo. Comprehensive comment.

      re “Most of these apartments have been pre-sold, otherwise the projects wouldn’t receive support from senior debt financiers (and mezzanine debt investors who are regular participants in the financing of residential development in Melbourne). At a minimum this would represent 75%-80% of the stock in the building.”

      Agreed, some projects have minimum presale financing requirements…but… this statement does not apply to HRH and others who self-finance. As previously noted these players face a massive exposure to capital losses if prices fall

      • I’m not aware of speculative apartment development in Melbourne of any material scale. The speculation is all on the part of the off the plan purchasers.

        Meriton/HRH isn’t active in Melbourne to my knowledge. But I agree, he would exposed to losses if he was forced to sell into a falling market. Although he has a larger balance sheet than most developers and would likely hold and ride out the storm in my opinion as he wouldn’t have financiers pushing him to liquidate and repay loans.

        • Re HRH/Meriton, those that don’t sell, he rents.

          I am going to ask him how many of his apartments are kept empty after overseas Chinese investors buy them OFT.

  9. The 6 (that’s right 6) new apartment blocks that have gone up within a KM of my place are now either finished or very close to it. Another one has just started. The average asking price I found (listed on real estate websites) for a two bedroom apartment in one of these ‘modern’ buildings? A bargain at $600,000.
    So if you can manage to scrounge up the $120,000 deposit, you can have the wonderfully ‘affordable’ mortgage payment (assuming just a 6% interest rate), of $2900 a month plus rates, maintenance and the rest. I’ll take my $370 a week rent thank you very much.

    Downward pressure on prices? Nah, joking right?

        • russellsmith55

          I think St Kilda is still pretty dysfunctional and would probably be the last to fall in a crash (and therefore fall harder as a result). There’s still a strong ‘desirability’ or ‘lifestyle’ premium on the prices.

          I know an outer suburbs Gen Y who bought an apartment there off the plan. Of course, his deposit required a large contribution from his parents. The reasoning behind it is the old ‘safe as houses’ story, buy now before you miss out forever etc.

          I wouldn’t mind renting there, but with a lot of the demand coming from volatile ‘lifestyle’ chasers and foreign investment, I’d have little confidence buying.

          • Totally agree. The great thing about renting here is there are a TONNE of properties on the market. I looked at about 5 places and got the first one I applied for (just loved it). Rent is reasonable and the area is great (close to everything).

            A guy I work with bought a place just up the road. Took a massive deposit and an even bigger mortgage. I find it hard to feel bad though, these days there is just no excuse.

            Last year I went to an auction around the corner. A small, three bedroom house. Run down in desperate need of repair. Sold for $950,000. Such a joke.

    • You live very close to me, Matt. I’m postcode 3181.

      We’ve got several large developments nearing completion near me and I think this has my landlord worried; there’s a huge one near the corner of High and Chapel due for completion before Xmas. There’s still more being built as we speak including some controversial ones:

      Personally I think we live in an area with a high saturation of public transport so I’m not against higher density developments despite what my neighbours think.

      • It’s great when you are moving home and need to get rid of useless rubbish. Construction bins are so useful.


  10. Clearly the melbourne picture isn’t that favourable based on the stats you have produced.

    Leith has Victoria broken the supply bottleneck that other states suffer from? I’m not saying that’s a good thing, but it certainly seems as if the shackles on supply are not existent there.

    • The extra FHOG Boost stimulated new builds to the extent that I think Melbourne is in an oversupply situation, and will probably be so for some years. I’m not sure what would stimulate migration to Melbourne to soak up that excess, there don’t appear to be any industries driving more employment.

      NSW has adjusted it’s FHOG scheme to favour new builds, so Sydney might be similarly affected in a few years – hard to say until we see the numbers.

  11. FINALLY, gravity starts to affect the 2nd biggest Australian housing market. Much of the mainstream media are STILL running spruiker stories even under the title “melt-down”

  12. Considering bad sales results who is funding construction in Melbourne? Is it funded by leverage or cash?

    • The post from Washo @ 10.58am covers it reasonably well. Major banks provide ing at say up to 80% of cost, mezzanine debt may make up the next 10%, and euiity from the project sponsor makes up the rest. So total leverage can be circa 90% of project cost (which might be ~75% of the project’s end value).

      The banks and mezz lenders will requre that a certain percentage of the units in the development are pre-sold prior to draw down of the facilities. These pre-sales will typically be enough to cover the repayment of all the principal and interst on the debt.

      Hence, from a lender’s viewpoint, the risk is more around whether the project completes and the pre-sales settle, rather than exposure to property price changes per se. It’s the pre-sales that allow the high levels of leverage to be employed – without them you wouldn’t get a loan facility.

  13. This all sounds positive for a prospective first home owner like myself, But how long would we expect to wait before you see actual prices dropping before they bottom out?

    ideally, i’m in no hurry, and would wait for it to almost bottom out before i buy.

    • You’ll know it’s time to buy when you stop seeing comments like the one you just made (about picking the bottom).

  14. …. yup, Melbourne is on the way down alright, tonnes of apartments on the market in docklands, most rentals offering 4 weeks free rent. The question is, is Sydney protected from this??? If we all ascribe to the view that recent housing over demand is basically a function of credit in our bubble economy (and most here do), then falling prices in melbourne will put pressure on confidence and the capital ratios of the big 4 – this affects ALL Australia. But agree that Sydney does not have the over supply, and has better beaches, weather etc. Still, it will be affected.

    • My thinking is that it will be the general tightening of credit that eventually gets Sydney.

      • MsSolarFelineAU

        Yeeeesss, AB, Those Who Owe “running out of money”. Cannot beat genuine unencumbered savings! 🙂

  15. and contrary tosome arguments, oversupply in apartments does reduce demand on stand alone houses – if you pay 500k on an apartment you might be prepared to pay 30 – 50% premium on a house in the same area. if you only have to pay 300k then that premium does not go so far. Ditto for rents – plenty of rental vacancy in melbourne suburbs now compared to a few years back. Young professionals now no longer have to come out to the suburbs as there is so much in teh CBD.

  16. Great work Washo, thanks. Another factor not mentioned regards perceived residential amenity/value of the high density apartment market, as compared to houses/land, is the often extremely high ongoing annual management fees. Costs of $5000-$8000 pa on top of one’s mortgage payments, not at all uncommon, like ouch! Of course if your only concern as an NG’ed off the plan investor is a tax break and depreciation claims…

    A few months back I checked out the display centre of the old CUB site redevelopment, two blocks up from Melbourne Central, with a view to possibly living there. All 570+ apartments were 1/2 bedders and so incredibly TINY (my garage in the outer burbs is bigger than the 2 bedders). All relative, I know, but I think I’d really struggle living in a place like that longer than 6 weeks. Maybe when I’m 80 it would be ok. Nothing at all suitable for families. After a long chat with the sales person, nice chap, he admitted the target market for the build/design was pretty much investors only, many of whom are offshore, with shortish term rental occupants in mind. When asked if he could nominate any city developments designed to suit permanent residency, he could not name me one, other than Freshwater Place (and these are priced totally in the stratosphere). So sad, its an iconic site, great location, all sacrificed on the alter of the negatively geared property ponzi.

    Real estate in Melbourne is bizzarro land. If I were a young one its a no brainer, I’d rent/share a house with friends.

    • MsSolarFelineAU

      Thankyou very much Pru for your contribution and observations. I googled and it’s developed by Australand! Of _course_ it gorgeous! 😉

      Having lived in Sydney CBD and having lived in the premium-build and sh*t build apartment buildings, there is a HUGE difference in actually LIVING in both. (or, attempting to *live* in the sh*t-quality buildings)

      The majority of these apartment developments NOT are designed for US local Australians TO LIVE IN. Unfortunately, in Brisbane, we’ve been infected with this same disease.

      Anyway, I’m a sittin’ back, saving $.

  17. Think back several years and we were confronted by headlines re. “runaway population growth” etc., largely a construct informed by various demographers, environmentalists (or anti immigration lobby) and of course the real estate industry, including Fairfax media.

    Significant component and spikes were caused by temporary residents included in the Net Overseas Migration NOM data, i.e. those spending 12/16 months in Australia, neither permanent residents nor immigrants (the ABS definition changed to include temps in 2006).

    Who were these temporary residents? International students and dependents (plus 457 temp workers and 2nd year Working Holiday Visa holders); but through scare campaigns in media the government panicked and forced Dept of Immigration to raise the bar on visa eligibility.

    Result of this, student welfare issues, violence, education quality and immigration changes (e.g. suspension of offshore applications), has been stagnating population growth and now I think declining…..

    So several years ago e.g. apartment investment and development was logical, now with tens of thousands of students missing in Melbourne, don’t hold your breath……

    Ironically, as the govt. realises it has severely impacted the economic health of universities, TAFE and private colleges, new student visa processing systems being intorduced now make it much easier to get a visa (it never was easy in the first place if you ignore media headlines).

  18. I think Forrest Gump explains it best when he said… “Stupid is…..What Stupid Does…

  19. Speaking of stupid, I looked at a cheap rental, advertised for $250/wk, including the first two weeks rent free. I said, “So really, it’s only $240/wk for 12 months then?” The look of confusion on the face of the realtor said it all.

    About Brisbane & Gold Coast medians forecast to be over $1M by 2025. Look at the link itself “housing may price itself out of market”. LOL