Unit prices to drop 15% to 20% – Stephen Walters

Stephen Walters – former chief economist for JPMorgan and now working for the Australian Institute of Company Directors says prices of apartments will fall 10 per cent to 15 per cent over the next one to two years, squeezing buy-to-let investors who have borrowed to negative gear and are heavily relying on capital gains. It is going to get ‘ugly’ he says and we ask for more information on where, what, when and how.


Kevin:  Reports flying in from all around Australia about what’s happening with unit prices. I’m going to pull into the conversation now the Chief Economist of The Australian Institute of Company Directors and also former Chief Economist with JP Morgan. Stephen Walters joins me.
Stephen, thanks for your time.
Stephen:  Hi there, Kevin.
Kevin:  I want to talk to you about your prediction of a 10% to 15% fall in apartment prices over the next couple of years. Is that right across Australia, or are there some patches worse than others?
Stephen:  No, certainly some parts of Australia will be worse than others. I’ve arrived at that conclusion just by looking at the supply/demand imbalances in some markets. Interestingly, the two real hotspots are inner-city Melbourne and inner-city Brisbane. There are also elements of other supply in inner-city Sydney, but it’s much less acute.
In that sense, I’m looking at the sheer amount of new apartments that are being constructed in both Brisbane and Melbourne inner city relative to the existing supply. That’s clearly identified the areas that when you look at demand for the apartments relative to the amount of new construction that’s going on, they really stand out as having some pretty serious oversupply over the next couple of years.
Kevin:  Is it a slowdown because of the number of buyers, or is it a slowdown because returns aren’t quite attractive enough for investors?
Stephen:  It’s a bit of everything. There has certainly been a bit of waning in demand, not much; it’s more of supply response at the moment. If you just look at the number of cranes and the amount of construction that’s going on, there’s a very big supply response going on. But don’t forget at the same time, there’s a bit more caution from the banks in terms of providing credit into that segment of the market.
I wouldn’t say the banks have really squeezed that part of the market, but it is a little bit more difficult as an investor – and particularly within that group, a foreign investor – to get credit to actually borrow into that apartment market.
It’s on both the supply side where there’s a massive increase, but also on the demand side. When you get in that combination of those two – we’ve seen this in the past – it typically is not that difficult to do the arithmetic on that. When you get a big increase in supply and a small decrease in demand, you’re going to have some problems.
Kevin:  Is there any evidence that this could be put down to how tough some of the restrictions are on foreign buyers? Is that slowing the market a bit?
Michael:  It is. The problem there is that it’s very hard to get statistics on foreign buyers. We do get a lot of information from the Foreign Investment Review Board, and foreign buyers are supposed to be registering with the FIRB, but often, there are ways to get around that.
We know that there has been a lot of buying that ostensibly is foreign buying but it comes through domestic sources, whether it’s relatives or friends or other means of actually buying domestically. It is a little bit difficult, but certainly, anecdotally, we’ve heard the banks talk about probably a less or a diminished willingness to lend into that sector.
Also, there has been a bit of concern about foreign buying about not just our residential real estate but other assets. I think there’s a general perception that there has been a bit of a slowing in that segment.
But on the flip side, anecdotally, you get plenty of evidence that there’s still plenty of demand by foreigners to buy assets in Australia. There are various reasons for that, whether it’s wanting to take their capital out of offshore markets for various reasons or simply that Australian property has been such a lucrative investment for a long time.
I think that, often, buyers are a bit slow to see what the underlying dynamics are in a market that clearly is looking at some pretty serious oversupply.
Kevin:  Are we seeing many defaulters at this time, Stephen?
Stephen:  Not yet. I think that’s still some way off. In the context here, remember that interest rates are at all-time lows and the unemployment rates is at a three-year low. The dynamics at the moment are quite good, so that’s not the place to look in terms of anticipating trouble.
I think you can see in the statistics on rents, in particular, that rents are actually already falling. This is what economists look for. When you’re looking for some pressure points in a market, you look for price signals, and the earliest price signal you get of oversupply in housing is that vacancy rates go up, and therefore, rents go down. We’re already seeing both of for those.
Defaults will come later, but I’m not anticipating a big rise in defaults. I think it’s interesting that the Reserve Bank in their Financial Stability Review that was released ten days ago or so came to a similar conclusion, that there’s likely to be an oversupply in some parts of the apartment market, but not widespread systemic distress with people unable to pay their mortgages or a collapse in the market.
But certainly, you can get price falls. We’ve seen it in the past where you get certain parts of the market, particularly high-density city apartment market, where prices do fall, but to get widespread defaults, I think you need something pretty serious to happen with unemployment going up and interest rates going up. And it’s very unlikely you’d see both of those at the same time.
Kevin:  I’m talking to Stephen Walters, who is the Chief Economist with Australian Institute of Company Directors, also former Chief Economist with JP Morgan.
I’m just wondering if there are any areas that are immune to some of these falling prices. You mentioned inner-city Brisbane and inner-city Melbourne in the opening. What about some of the other areas – beachside areas, as an example?
Stephen:  This is the problem with residential investment. It’s very hard to generalize across an entire market. We’re only looking at the apartment segment of the market, let alone certain parts of that. I think there’s always differentiated products, whether it’s coastal or, for example, in Sydney, if it’s near the harbor, or in other parts of the country, whether it’s on the river or on the coast.
There are always advantages for some parts of that residential property market, but remember there’s another market out there that’s not the high-density dwelling segment at all; it’s the detached housing segment. I don’t actually see a particular problem there. I think in the detached market segment, where there’s a much bigger land component of the price, I don’t see an oversupply in that market at all. In fact, you could argue there’s an undersupply there.
We have to be careful about extending what I think will be some problems in those inner-city markets in those particular cities to the broader housing market because I think it’s unlikely we’re going to see sustained price falls in the house market generally.
But I think when you’re looking at inner city away from the coast, away from the harbor, for example, in other parts of Australia, there’s likely to be some pretty serious price weakness. But you’ll quite likely see prices holding up in other parts of the country within the same city.
Kevin:  You mentioned that falling rents are a bit of an indicator that that particular part of the market could be in strife. What are the other indicators? Are there any others that would indicate that things are on a downward trend?
Stephen:  Vacancy rates are going up, so that’s the clear one that typically leads to rents. We’ve seen, not in a serious way, but vacancy rates have been ticking up in those two cities I mentioned, Brisbane and Melbourne, in particular, and including in Sydney.
I think that’s the place to watch in the near, term because rents tend to be a little bit slow to react. People tend to have their lease locked in for perhaps 6 or 12 months, or possibly even longer, so you don’t see their rents adjust down until the actual tenancy ends. So vacancy rates are often a good one to look at, and we’ve seen those going up already.
But I think also, some of the official published data you get from the Bureau of Statistics on dwelling completions, for example. It’s not hard to match up the amount of supply that’s coming onto the market relative to the amount of dwellings that are already there.
We’re getting some pretty serious numbers. Between 5% and 8% of dwellings that are already completed are coming onto the market in addition to what is already there. We haven’t seen those sorts of levels for at least two decades in terms of new supply coming on.
Certainly vacancy rates are the place to watch followed by the rents. But I think ultimately, you’re likely to see prices come off as well because given that, certainly, investors are very active in that high-density inner-city apartment market, if you’re getting lower returns each month because your rental income is falling, you’re likely to get lower prices, as well. That’s a cascading effect, so look at the vacancy rates, watch the rents, and ultimately, watch the prices.
Kevin:  Great advice. Stephen, thank you very much for your time.
Stephen:  My pleasure, Kevin.

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