Oversupply Fears Rise as LVRs Drop

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Market Update
You may have noticed bearish headlines over the past few weeks where the property market and its affiliates were referenced, with words such as tightening, clamping and crunching being used. This is unsurprising given the downswing we are entering in the market cycle, but I believe further context and data are needed for a more grounded perspective.

The latest property market data and analysis has revealed stagnant growth in the Sydney house market, a historical high unit median for the Sydney market, easing in Melbourne and an ease in the fall of growth in the resource regions of Western Australia and the Northern Territory.

Table 1 presents the statistics summary for April.

Table 1: April 2016 Summary

As you can see in the table, quarterly growth in Sydney house values was a modest 0.03%. This comes off the back of losses in the March quarter, and the result is a stagnant median house value of just over $1,040,000 – where it has been hovering since January.

On the other hand, units in the Sydney market increased a significant 1.26% over the April quarter. This follows losses in January and the median value is now at a historical high of $695,000.

The Melbourne market experienced more significant easing in the April quarter, with declines in median values of approximately $5,000 and $3,000 in the house and unit markets respectively. With Melbourne having a tendency to follow Sydney at a lag, there could be further short-term fluctuations in this market to come over the next few months – rather than a distinct downward trend.

Property values continue to fall in the resource regions of Western Australia and the Northern Territory. However, even though April quarterly growth remained in negative territory in the Perth and Darwin house markets, the figures were slightly better than those recorded in the March quarter, suggesting an ease in the fall of growth. Annual growth for these markets is presented in Graph 1.

Graph 1: Annual Growth Rates – Perth and Darwin
property market
Source: Onthehouse.com.au

The graph shows that property values have been falling in these areas throughout much of 2015 up to today. It has been established that movements in commodities can be closely tied to economic and housing market performance in WA and the NT. Despite a small rally in the commodity price index in the first quarter of 2016, iron ore is still less than one third of what it was worth when it peaked at US$180 in February 2011.

Additionally, profits from the mining sector are not as widely spread throughout the states, as the operational phase of the mining boom employs less labour than the construction period. Interestingly, it seems that the Queensland labour market is suffering a higher unemployment rate (6.5%) in response to mining divestment. This could be because of the tighter labour markets in WA and the NT, where workers have higher mobility in response to mining and construction projects.

Oversupply Fears Rise as LVRs Drop

News of Macquarie Bank tightening its loan to value ratio (LVR) for apartment high-rises has sparked fears of an oversupply in certain markets. The bank named 46 postcodes where high-rise apartment lending would shrink to 70% of the value of the property. The problem in these postcodes – which are concentrated in inner Sydney, Melbourne and Brisbane – is not one of supply and demand, at least not in the sense that there are more apartments than there are people to live in them. Supply and demand in these markets is not a question of how many people need a place to live versus how many places there are to live. Rather it is how many owner-occupiers and investors demand assets.

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The former conception of supply and demand ignores the tax and finance incentives that encourage people to hold more property than they need to live in. These incentives include cash-free equity deposits, negative gearing and capital gains concessions, which have been introduced one by one into the housing market over the last 30 years. It makes sense then, that our understanding of supply and demand in real estate should be dynamic. As long as there is an investor looking for a property to put their money in, there is demand. As long as there is an investor demanding property, a developer is willing to supply.

Professor Laurence Murphy of the University of Auckland notes that when the price of property begins to fall, developers become less willing to supply dwellings. Graph 2 and 3 compare high-rise approval data in Victoria and NSW (which we have to assume is a proxy for inner city unit development) with quarterly growth rates in their respective unit markets.

Graph 2: Quarterly Approval Figures Victoria vs. Melbourne Units Quarterly Growth Rates
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Source: Onthehouse.com.au

Graph 3: Quarterly Approval Figures NSW vs. Sydney Units Quarterly Growth Rates
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Source: Onthehouse.com.au

The graphs show that approvals are highly responsive to changes in unit growth rates.

As demand for units falls away due to tighter LVRs, slowed wage growth and higher premiums on foreign investment purchases[1], the first thing to crash will most likely be applications and construction of dwellings. This has wider economic implications, particularly for Victoria and NSW, where construction has been a significant contributor to growth in gross state product.

The construction of units – whether in the application, construction or completion phase – moves in much larger fluctuations than the values of the units themselves. For example, in the September quarter of 2010, the number of approvals for units in blocks of four or more stories grew by 124% in NSW, yet nothing dramatic happened with Sydney unit value growth. Values grew steadily until 2013 when they began to grow at a higher rate. I am not saying that the supply of units to speculative investors is sustainable where population growth is low, nor is it optimal for the people living in them. However, it is clear that price movements and investor interest in units are a better indicator of expected supply movements than population growth rates.

The graphs also show the approval figures for other dwelling types over the past decade. Most strikingly, the number of high-rise units began outperforming detached housing approvals from March 2011. The salience of this phenomenon increased around the beginning of the 2013 housing boom.

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Less important than the effect of supply on the value of a unit is the way units are supplied and how they are integrated with wider planning. Residential dwellings crowding out commercial and cultural facilities, which are partly what makes a city desirable in the first place, can limit a city’s desirability. A lack of diverse planning can also increase pressure on transport and road congestion. This is one of the many risks of investing in rapid high-rise growth areas, and has caused some young families and retirees to move to regional parts of the state.


Across the country, the transition from mining to service industries is overstated in its ability to absorb lost jobs and income. The official Australian unemployment rate was 5.7% in April (seasonally adjusted), unchanged from the previous month. However, April saw the loss of 9,300 full time jobs and an increase in 20,000 part time positions. While the official statistics imply a steady unemployment rate, employment is being picked up through more precarious work.

Given that part time and casual work has been linked to reduced bargaining power for pay increases, it is no surprise that increases in Australia’s annual wage growth reached a historic low of 2.1% in the March quarter. Low wages may also be contributing to low inflation, which is in turn fueling expectations of further cash rate cuts this year.

Moving forward, I would expect modest falls in house values in the major east coast cities, while units and resource market dwellings adjust to changed conditions in demand. Low interest rates and falling dwelling prices may present opportunity in certain markets across the country, but purchasers should look for strong and diverse economic fundamentals in the markets they choose to buy in.

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[1]According to Foreign Investment Review Board data, foreign investment makes up a small, but rapidly increasing percentage of the value of transactions in our housing market. Scholars have noted that official data suggests foreign investment is not significant enough to be pushing up dwelling values. Furthermore, higher premiums on the purchase of property in Australia may not deter foreign investors, but would raise government revenue should demand remain steady. The price elasticity of demand from foreign investors in Australian real estate remains to be seen.




Eliza Owen onthehouse

Disclaimer: This article contains general information; before you make any financial or investment decision you should seek professional advice to take into account your individual objectives, financial situation and individual needs. Click for more detail regarding this disclaimer.

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