NAB: It's not time to worry about Australia's apartment market... yet

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Australia is in the midst of an epic apartment building boom, unprecedented in its scale.

It seems everywhere you look, particularly in Australia’s southeastern capitals, are cranes going up left, right and centre. A walk down Bourke Street in Sydney today would reveal seven obvious cranes, perhaps more on closer inspection. All building residential apartments, all in close proximity.

It is amazing. And, to some, concerning.

With so much supply under construction already under way, and a whole heap more to come if recent building approvals are anything to go by, there are understandable concerns brewing about the outlook for apartment prices, and, further up the supply chain, those who are building them.

In particular, most concern seems to be directed towards the Brisbane and Melbourne apartment markets. The RBA certainly is watching developments in closely, warning last year of a potential oversupply of apartments in inner city areas of both cities. Economists at Citibank agree, writing last month that Brisbane’s market was already oversupplied with Melbourne well on the way.

Sydney, due to years of chronic under supply of new dwelling construction, is not deemed to be in the same situation as those capitals to its north and south despite being the home to the largest number of apartments under construction at present.

While others are concerned about recent developments in some capital cities, Ivan Colhoun, chief markets economist at the NAB, isn’t overly fussed, at least not yet, noting in a research report released on Monday that “vacancy rates in Sydney, Melbourne and Brisbane currently remain around or slightly below long-term averages”.

However, while he’s not concerned at present, Colhoun suggests that the true test for markets deemed at risk of oversupply will lie in the years ahead.

“There are now some 220,000 dwellings under construction, nearly 40% more than the 150-160,000 annual commencements that occurred in most years between 2006 and 2013,” he says. “The ‘absorption’ of these apartments into the market will be required over the next 12-24 months, meaning the issue of apartment supply, vacancy rates and apartment prices will be one that receives considerable attention over the next few years.”

As this chart from CoreLogic shows below, apartments currently under construction already stand at unprecedented levels, and are continuing to increase at a rapid pace.

Further clouding the outlook for prices, hence settlement risks, Colhoun suggests that “the presence of significant numbers of foreign investors in these apartment approvals along with foreign financing of property developers and tightened lending restrictions by APRA and the local banks complicates assessment of the situation”.

According to a recent survey conducted by ANZ in consultation with the Australian Property Council, foreign investors accounted for 23.9% of all property sales in Australia during the June quarter of this year. The proportion of sales in Victoria and New South Wales were the highest in the country, accounting for 30.8% and 25.4% of all sales over the same period.

However, despite those uncertainties, he believes that settlement risks on newly built apartments, while increasing, aren’t overly alarming as yet.

Colhoun explains:

Recent trends and reports suggest there has been a modest increase in delays in settlement rather than outright non-settlement. And it is typically foreign buyers that are now finding it somewhat harder to access finance and/or expatriate finance (the latter largely from China).

That said, given the continuing increase in prices that has occurred in recent years, these off the plan purchases of some two years ago are often currently sitting on reasonable unrealised capital gains. This is providing a strong incentive for owners to settle on the dwellings – and reportedly – along with the deposit – is currently providing a reasonable buffer for developers that are forced to sell any non-settled properties

While he believes that “conditions for serious stress in the apartment market are not currently met”, Colhoun suggests that an increase in interest rates, or a lift in unemployment, could amplify settlement risks at a time when so much supply is entering the market.

The outlook would be more concerning if the potential for oversupply were likely to coincide either with higher interest rates or higher unemployment (particularly the latter). For now, neither of these pressures seems likely to coexist with apartment over-supply, meaning moderate declines in apartment prices in areas with oversupply seem to be the base case scenario, rather than something more concerning at this stage.

In a research note released in May, Cameron Kusher, research analyst at CoreLogic, suggested that tighter restrictions on investor and overseas buyers from Australian banks were two factors that could amplify settlement risks for newly built apartments in the years ahead.

“Mortgage lenders have recently tightened their lending criteria, subsequently some people who have committed to off-the-plan units may not be able to borrow as much as they could at the time of signing the contract,” said Kusher.

As a result, Kusher noted that there was a clear risk that some properties may be be worth less than the price they were purchased for off the plan, heightening settlement risks.

“Many of the units are coming up for settlement in similar locations and will compete with existing unit stock,” he said.

“With so much stock coming online at once there is an increasing concern as to whether settlement valuations will actually meet the contract price of these units.”

As yet no severe price declines have been witnessed across Australia’s eastern capitals, alleviating settlement concerns for the moment. However, as communicated by Colhoun and Kusher, the true test likely lies ahead.

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