Melbourne city is the centre of an oversupply of apartments, an explosion creeping up on the Australian market over the next two years.
Mortgages in this area have the least additional equity of any inner city area when it comes to absorbing any losses because apartment price rises have been relatively low, says Moody’s Investors Service.
Apartment prices in high population density areas in Australia have generally been rising, providing additional equity to absorb losses in an event of borrower default.
“Mortgages on apartments in high-density regions are performing well and have low delinquency rates on average,” Moody’s says.
“However, the large oncoming supply of new apartments in these regions will pressure both real estate prices and rental returns from investment properties in these regions, which will in turn pressure mortgage performance.”
According to Moody’s, 117,518 new apartments are being built in Australia the next 24 months — 14,353 of them in inner Melbourne.
In Melbourne city, where the largest number of new apartments is expected to be completed over the next two years, the weighted average additional equity is just 7.6%. For the Yarra area it is 7% and Port Phillip 7.4%.
Sydney’s inner city, where the third largest number of new apartments is expected to be completed over the next two years, the weighted average additional equity is 19.7%.
Apartment prices in Sydney have increased by 40% over the last five years, compared with just 5% in the centre of Melbourne.
This chart shows the difference in price rises between inner Melbourne and inner Sydney:
Additional equity for mortgages on apartments averages 15% across all high-density areas.
A high proportion of mortgages on apartments in high density areas are investment and interest only, rather than principle interest loans, which adds to the risk.
In Australia, housing investors favour apartments over houses because apartments typically have lower prices and generate higher yields when compared to houses.
In Melbourne city, the share of apartment investment loans is 63%, the highest of any of the high density areas.
Investment and interest only mortgages are typically riskier than owner occupier and principle and interest mortgages, because borrowers typically repay loans at a slower pace and will therefore build equity more slowly.
Here’s the geographic spread of new apartments over the next two years with average additional equity calculated by Moody’s:
NOTE: WA CLTV: weighted-average current LTV. WA ILTV: weighted average indexed LTV. IO: Interest only. Additional equity is the difference between the LTV (loan-to-value) on a mortgage based on the property price at loan origination (CLTV) and the LTV on a mortgage based on the current property price (ILTV)