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Key takeaways
Over the last decade or so, the capital growth of most Melbourne apartments has been underwhelming, to put it mildly.
Detailed analysis of the established unit market (i.e. townhouses and apartments) shows established units are currently undervalued by between +15% to +20% and given the supply / demand imbalance will continue to correct upwards over 2024 as the market finds a new equilibrium.
The timing for when this occurs comes down to when rates start to be cut and when Government incentives are introduced (which is discussed below) however the industry needs to prepare for dramatic price increases in new off the plan apartments of +25% to +30% (compared to prepandemic prices) over the next 12-18 months across many sub-markets.
A critical factor to consider, and which has been underestimated by the market, is that the gap between new off the plan apartments and established and recently completed apartments is itself up to +30% in many sub-markets due to the economic costs of delivery of new apartments.
2024 is shaping up to be an extraordinary year for established “family-friendly” apartments (what many of us call “flats”) in Melbourne.
These aren’t your run-of-the-mill units; we’re talking about properties that exude unique charm, offer generous space for comfortable living, and are nestled in neighbourhoods where heritage protections ensure the preservation of character.
These factors aren’t just appealing—they’re fundamental to maintaining value in a fluctuating market.
Let’s unpack the historical context
Over the last decade or so, the capital growth of most Melbourne apartments has been underwhelming, to put it mildly.
This was in part because of a significant wave of new apartment development, creating an oversupply until recently.
But this price stagnation has set the stage for a compelling market correction.
The price gap between median apartment and median house values in Melbourne has risen to 55%, positioning these units as undervalued assets ready for savvy investor attention.
Moving forward, demand for well-located apartments is going to outstrip supply for some time to come as we experience record levels of immigration at a time when we’re not building anywhere as many properties as we require.
At the same time, the cost of construction of delivering new apartments will keep increasing not only because of supply chain issues and the lack of sufficient skilled labour but also because builders and developers will only commence new projects if they are financially viable and currently new projects will need to come on line at considerably higher prices than the current market price.
Now, if we zoom in on the localities poised for a rebound, we’re looking at a diverse palette of inner and middle-ring suburbs.
South Yarra, Toorak, and Armadale offer that quintessential upscale living; East Melbourne exudes a historical allure; while Carlton North and Brunswick add a touch of urban chic.
Prahran, Elwood, St Kilda, Malvern, and Hawthorn complete this mosaic with their own unique blend of lifestyle and investment potential.
A valuer’s thoughts about Melbourne apartments
Recently Charter Keck Kramer, a leading Australian firm of property consultants and valuers, wrote a detailed report on their assessment of the Melbourne unit market.
These types of assessments are always difficult to interpret because they take into account apartments, townhouses, villa units, high-rise apartments, and low density, family-friendly apartments; however, their analysis of Melbourne’s housing market shows that the price gap between detached houses and established units is 55% (the pre-pandemic average was 35%).
Here’s what they had to say:
Importantly, our detailed analysis of the established unit market (i.e. townhouses and apartments) shows established units are currently undervalued by between +15% to +20% and given the supply / demand imbalance will continue to correct upwards over 2024 as the market finds a new equilibrium.
Furthermore, the percentage of household income required to service a mortgage on a median priced house is now almost 50% which is the highest ever recorded.
When this is considered in light of the deposit hurdle and diminished purchasing capacity of buyers, many will simply need to make trade-offs should they wish to enter the For Sale market with greater demand to be driven into the BTS apartment market.
A critical factor to consider, and which has been underestimated by the market, is that the gap between new off the plan apartments and established and recently completed apartments is itself up to +30% in many sub-markets due to the economic costs of delivery of new apartments.
In essence, this means that at present the price proposition for a new off the plan apartment is not as attractive as that of an established apartment.
In summary, our analysis suggests that the established unit market (townhouses and apartments) will need to continue to reprice upwards (by around +15% to +20%) until the house price hierarchy is once again established.
It is at this point that new off the plan apartments will be able to be delivered at price points which again make apartment development feasible.
The timing for when this occurs comes down to when rates start to be cut and when Government incentives are introduced (which is discussed below) however the industry needs to prepare for dramatic price increases in new off the plan apartments of +25% to +30% (compared to prepandemic prices) over the next 12-18 months across many sub-markets.
Avoid off-the-plan apartments and those built in the last decade
Be careful… ‘off-the-plan’ apartments and those in large, high-density blocks (think more than 15-20 units) rarely match the performance of their scarcer counterparts.
Scarcity isn’t just a buzzword—it’s the engine driving capital growth, making these larger developments less attractive from an investment standpoint.
Sure new apartments come with the promise of “depreciation benefits” but typically these tax benefits dissipate after 5 to 7 years and most new apartments have little capital growth over the first 5 to 7 years, so these balance out.
It’s akin to the depreciation of a new car; once it exits the showroom, its value decreases sharply.
Remember the old cornerstone of property investment wisdom: while buildings depreciate, land appreciates.
So targeting a unit in a small, low-density —let’s say 4, 6, or 8-unit exclusive block in a prime suburb means you’re investing in the land’s intrinsic value.
Shifting demographics and investment implications
Rental vacancy rates in Melbourne have plummeted to less than 1%, and rent has been skyrocketing.
This scarcity of rental options is nudging more renters towards homeownership, a significant shift in consumer behaviour.
Moreover, there’s a growing trend among international students—or rather, their families—opting to purchase property in Australia as a response to the limited student accommodation options.
This pivot from traditional renting signals a deeper change in the investment landscape.
Historically, investment-grade flats in Melbourne’s verdant suburbs have been the battleground for investors and owner-occupiers alike.
However, we’re now witnessing a pronounced trend: owner-occupiers are increasingly becoming the primary buyers.
This is unprecedented—95% of these flats are being snapped up by those looking to occupy rather than invest.
The factors at play may include recent legislative changes affecting tenancy laws, increased land taxes, and shifts in affordability.
This trend is reshaping the market and indicating a potential investor retreat, which is cause for concern regarding the vitality of the private rental market.
In my mind, a recalibration of government policies is required to re-engage investor interest and balance the market.
Melbourne’s market revitalization is on the horizon
Looking ahead, Melbourne’s apartment market is well-positioned to reverse its poor growth trajectory of the past 5 years.
The unrefuted trend in all investment markets is mean reversion.
This means that a period of below-average returns is always followed by a period of above-average returns.
The target is to align with the historical 40-year average growth rate of 6-7%.
With the likelihood of interest rate reductions in the latter part of 2024, we could be at the cusp of a growth surge, potentially hitting an impressive 8-10% in Melbourne property values.
This would mean a substantial catch-up to Sydney, where the median house price currently stands at $1,400,000 compared to Melbourne’s $940,000—a disparity that’s as wide as I’ve ever seen.
That’s why I believe that investment-grade Melbourne apartments look attractive compared to other markets and that several economic tailwinds may result in median apartment prices doubling over the next decade.
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