Is the investment-grade apartment market primed for growth?

By February 4, 2020 Property Investing
apartments

Over the past few years I have observed a strong trend of investment-grade house prices growing a a much faster rate than apartments. It is true that all markets move in cycles and all cycles come to an end, eventually. It’s my thesis that several factors (such as the fall in the volume of new apartments, contraction of borrowing capacity and high population growth) are conspiring to create a growth cycle for older-style, investment-grade apartments. Here’s why…

Supply of new build apartments drying up, fast

Development approvals for new apartments has been falling dramatically over the past few years. In Sydney, the volume of new apartments approved for construction has more than halved since its peak in 2016. In Melbourne, approvals have fallen nearly 40% in the last 18 months. The Brisbane apartment market is almost non-existing with less than a quarter of the volume compared to the peak in 2016.   

apartment approvals

Major residential developments typically have a lead time of at least 18 to 24 months (i.e. planning through to construction). Therefore, if this trend continues, there will be a massive supply-shortage of apartments within the next few years. There is still some pipeline stock to come onto the market, however, once those properties are completed, supply is expected to fall.

New-build apartments aren’t constructed with the secondary market in mind

Purchasing a new build apartment and an establish apartment are materially different things.

Typically, a brand-new apartment purchaser is influenced by things such as its finish and building amenities such as theatre rooms, pools and gyms. In the beginning, these buildings are all shiny and new and present very well. However, they tend to wear and tear quickly and these largely superficial attributes become far less persuasive (and costly to maintain).

Conversely, established apartment buyers rarely focus on these factors – mainly because older style buildings rarely offer such amenities. Instead, these buyers tend to focus on factors such as location, privacy, soundproofing, natural light, smaller blocks (fewer tenants) and so on.

Understandably, when you compare a brand-new apartment to an established apartment, the shiny new object gets all the attention. However, because a newer apartment is no longer shiny after 3 to 5 years of wear and tear, an older-style apartment starts to look comparatively more attractive.

Borrowing capacity is diminished 

It has been very well documented that borrowing capacity has contracted significantly over the past few years. This means a property buyer’s purchasing power is less which forces them choose between two options. First, an apartment in a nice, blue-chip suburb close to everything. Or, second, a house in the outer suburbs. Many people will choose the first option. Consequently, I predict the reduction of borrowing capacity will force more property buyers into the apartment market.

Houses are too expensive for many people

Approximately ten years ago it was possible to purchase an investment-grade house in Melbourne for around $800,000. However, today, you need over $1 million. Therefore, if your budget is $800,000 you have two options. You can purchase an apartment, not a house. Or you can find a house in an adjoining, non-investment-grade suburb (i.e. compromise on the investment’s quality).

With house prices continuing to increase, an increasing number of property buyers will be forced into the apartment market.

Cladding and building quality issues make new apartments harder to sell

Building quality issues in a few Sydney apartment complexes (e.g. Opal Tower and Mascot Tower) were well publicised during 2019. It is unclear how much of the restoration liability rests with the owners, but it’s safe to say that they will likely suffer some loss.

In addition, many buildings are investigating the type of cladding used to ensure its adequately fire retardant, to avoid a repeat of the Grenfell Tower fire in London in 2017.

These issues will impair the marketability of new-build apartment complexes. Consequently, developers will need to spend more money on marketing as well as improve the quality of their construction (higher cost). Both of these factors make constructing new residential towers less attractive to developers – and less attractive to property purchasers too.

Population growth marches on

According to the ABS, over the past 8 years, Victoria’s population has increased at a rate of between 100,000 and 150,000 people per year (rolling 12 months average) and NSW by between 75,000 and 130,000 people. Population growth in both states is driven heavily by overseas migration. Interstate migration is negative in NSW (minus 15,000 – 20,000 people per year) whereas its positive in Victoria (plus 12,000 – 15,000 people per year).

If this growth continues, and supply of new apartments fall as indicated above, this imbalance in supply and demand will inevitably translate to property price growth. 

In the last 10 years, we have constructed too many apartments

The chart below compares Victoria’s population growth with Melbourne apartment approvals. In 2011 approximately 24,000 apartments were approved when Victoria’s annual population growth was only 75,000 – but 32% of people probably don’t want to live in an apartment! It appears that current construction volumes are now at a more sustainable level.

apartments v population

Steer clear of Brisbane apartments

I do not advise any of my clients invest in apartments in Brisbane (at the moment). Brisbane’s population growth is mainly driven by overseas migration as interstate migrants go to the Gold and Sunshine coasts e.g. retirees. Overseas migrants tend to be skilled workers and Brisbane has the best job opportunities in Queensland. These migrants tend to be young families and need a house, not an apartment. In addition, the apartment market is still in over-supply and it will take many years until this surplus stock is absorbed by demand (natural population growth). 

But not all apartments are good investments

You are probably sick of reading this, but it must be said: “not all apartments will make good investments”. In fact, I would say that very few apartments can be regarded as investment-grade. Therefore, I always recommend that people engage a reputable and experienced buyers’ agent to assist them with selecting the right property to invest in. This blog will remind you of the three attributes needed for a property to be deemed investment-grade i.e. strong land value component, scarcity and proven performance.

Markets move in cycles

It is my observation that apartments have dramatically underperformed houses over the past five to ten years i.e. house prices have increased at a much higher rate. As I illustrated in this blog (using historical data), most property markets move in cycles. A high growth period of 7 to 10 years is typically followed by a low-growth period. If we agree that the established (investment-grade) apartment market has recently been in a low-growth phase, that should mean a higher growth phase will follow. I predict this growth phase will begin in the next five years, for the reasons discussed above.

If you need assistance with your property investment plans, including a referral to a reputable buyers’ agent, please don’t hesitate to reach out.