There is a lot of negative sentiment and general apprehension at present surrounding the apartment markets in Melbourne. It is Charter Keck Cramer’s view that this is not reflective of the entire market, nor is it reflective of everything that we are actually seeing and hearing on the ground, nor what is in fact starting to emerge in the statistics.
The Research & Strategy team at Charter Keck Cramer has been asked by a number of our clients whether it is possible to increase Build to Sell (BTS) off the plan apartment value rates in their projects in light of the substantial increase in construction costs over 2020-2023. Given the Charter Keck Cramer Research & Strategy team’s mission is to provide evidence-based and forwarding-looking insights that assist the industry with their investment and development decisions we have investigated this and made some of our views publicly available.
Summary
At the outset, it is acknowledged that conditions in the BTS apartment market are arguably the toughest they have ever been. The market has moved incredibly quickly over the last 12-18 months in light of the volatility and “push and pull” of rapid interest rate rises, the strong return of overseas migration, substantial increase in construction costs and volatile consumer sentiment. These factors are making many apartment projects unfeasible and leading to very slow sales rates. They are also causing rents to increase substantially.
There are however a number of fundamental reasons that support the thesis that off the plan apartment value rates across the entire apartment market in Melbourne will simply have to recalibrate upwards over the next 12 months. In fact, our analysis of apartment projects across 10 suburbs in Melbourne shows that several of those that have been released over 2023 have increased their off the plan value rates by +15% to +25% (compared to pre-COVID off the plan value rates of apartments of the same size in earlier stages of the same development or in comparable projects in the same locations) and these projects are being met with market acceptance (albeit still slowly).
We emphasise however, that whilst this is just starting to occur, it is not yet possible for every project in every location to revise off the plan value rates upwards. At present, the ability to increase value rates comes down to the developer, brand, location and respective target markets.
In summary, our view is that the buyer market will need to accept this new pricing structure given it is unlikely that land values will fall substantially nor will building costs fall dramatically. In fact, Charter Keck Cramer’s view is that in Melbourne, the pre-COVID off the plan value rate of $10,000/sqm is now closer to $12,000/sqm, whilst the pre-COVID off the plan value rate of $12,000/sqm is now closer to $14,000/sqm. This requires a change in mindset that needs to be led by the development and financer industry after which the buyer market is anticipated to follow.
Set out below are some key factors for the industry to critically assess with respect to their projects and the apartment market more broadly.
Interest Rates & Consumer Sentiment
Interest rates have increased by 400 basis points since April 2022. This has diminished purchaser capacity by over -40%. Furthermore, consumer sentiment, as measured by the Westpac Melbourne Institute of Consumer Sentiment Index, remains in deeply pessimistic territory.
On the face of it, this appears to be a major risk for the apartment sector. It is also certainly one of the explanations for slow pre-sales rates in many projects. However, Charter Keck Cramer suggests that both of these factors stand to open up a very large (but slightly different) buyer and renter pool over the next 12+ months. The BTS apartment developers that understand and respond to these respective target markets stand to benefit.
When rates were at 0.1%, all potential buyers had much higher purchasing capacities. A segment of this cohort had the capacity to purchase a detached house or a townhouse whilst another segment that had the capacity to purchase an apartment. With rapid rate rises, there is anticipated to be a “shuffle” downwards (trade-off) where many buyers are forced to trade into medium and higher density dwellings as dictated by their revised finances.
For those that do not wish to buy, or now cannot afford to buy, will still need a place to live. This in itself provides renter demand which will be attractive to BTS apartment investors (as well as Build to Rent operators). Finally, with rapidly rising rents, it is also anticipated that some renters may make a financial decision to purchase and pay off a mortgage given that rental repayments may be similar to mortgage repayments in some markets and across various product types. It is anticipated that almost all of these potential buyers will seek the most affordable product type which will be BTS apartments.
This is the first key factor suggesting that BTS apartment pricing will need to adjust upwards and will be supported by the buyer market.
Gap Between Houses and Units
A metric that has historically been used to analyse the apartment market is the house to unit price ratio (or house to unit price “gap”). This is broadly based on the “house price hierarchy” which suggests that Australian buyers typically aspire to reside in a detached house in the location of their choice, but often trade-off dwelling type for location and purchase into medium or higher density dwellings in the location of their choice.
The long-term (10 year) gap between house and units in Melbourne has been 47%. The current short-term (2 year) gap is currently 60%. This is a function of the significant market distortions caused as a result of COVID where detached house prices increased by +24% over 2020-2022.
Charter Keck Cramer however cautions that this analysis, whilst helpful, must be fully understood to be meaningful. The “unit” dataset of most data providers comprises townhouses, terrace houses, villa units as well as flats and apartments and is not a true reflection of the prices of new contemporary apartments. Given that historically more medium density dwellings such as villa units, townhouses and terraces were delivered across Melbourne (at higher price points compared to contemporary new apartments) the gap was much closer a decade ago when compared to more recent times where greater numbers of contemporary apartments (at lower prices) have been delivered which has subsequently widened the gap.
That being said, the gap between houses and units is extremely large at present and in many respects the market is out of long-term equilibrium. Whilst house prices have fallen -9% since March 2022 house prices are still +15% higher than pre-COVID and are not anticipated to fall much further (in fact they may well continue to increase). Given the rapid rate rises, buyer demand will continue to be driven into more affordable dwelling types and BTS apartments stand to be the primary beneficiary of this dynamic.
This is the second key factor suggesting that apartment pricing will need to adjust upwards and will be supported by the buyer market. |
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