Is Sydney’s housing boom about to bust?

After a decade of frenetic construction, could the apartment boom be about to bust?

Sydney’s recent housing boom has largely been about new apartments, but after a decade of frenetic construction, could the glut of new apartments signal a bust is on the way?

In the first 60 years after the end of World War II, home for most Australians meant a detached house with a garden, typically in the sprawling suburbs of one of the state capitals.

However, after 2010, all that started to change. From a long-term average of one in three new housing developments being apartments, the number of apartments and townhouses being built in Australia skyrocketed. December 2012 saw a remarkable milestone: for the first time on record, houses made up the minority of new dwellings approved for construction.

As a result, the face of Australia’s cities is being transformed. At the time of the 2011 census, only 13.6 per cent of Australian dwellings were flats, units or apartments. Since then, according to the Reserve Bank of Australia, the total number of apartments in Melbourne and Brisbane has risen by around a third, and in Sydney by a fifth. By November 2016, across New South Wales there were around 1.3 new apartments, units or townhouses approved each month for every detached house.

This major shift has prompted the question: after a decade of frenetic construction, could the apartment boom be about to bust? 

The peak in 2015?

TWT Property Group is one of the new breed of mid-size developers helping to drive the surge in apartment construction. Based in Australia and backed by Chinese investors, it combines property development with funds management and strategic development advice.

The group’s latest project is a 210-apartment complex in Ultimo, on the fringe of Sydney’s Chinatown. According to general manager Stephen Fitzpatrick, demand has been strong, much of it driven by investors, both Australian and international.

“We were predicting sales around A$16,000 per square metre for a two-bedroom apartment,” he says. That would have delivered investors a yield of around 4 per cent.

“Now we’re selling them for around A$20,000 per square metre, and obviously rents haven’t gone up much in that time, so yields will be contracted. It’s a big increase.”

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Fitzpatrick adds, “We may look back on 2015 as a peak in demand for this cycle. Some segments of the market will certainly be in oversupply. Brisbane and certain parts of Melbourne are probably already there.”

Yet he still believes the Sydney market remains healthy. “It’s quite obvious that Sydney definitely has been in an undersupply situation,” he says.

“I don’t particularly like to use the word ‘boom’ because it generally means there will also be a bust at some point. I am firmly … of the belief that the market will correct itself, hopefully with a minimum of government intervention,” Fitzpatrick concludes.

OECD data shows both Canada and New Zealand have undergone similar building booms. South Korea has experienced an even faster rate of growth, with quarterly dwelling approvals doubling in the decade to March 2016.

Sydney’s population explosion

Sydney continues to face a chronic undersupply of housing, says Giovanni Cirillo, managing director of the Planning Lab consultancy and former executive director for urban renewal and major sites in the NSW Department of Planning.

“In Sydney, there is underlying demand for around 30,000 to 40,000 additional dwellings per year,” he says, “but traditionally the rate of supply over the last 40 years has been around 15,000 dwellings a year; 2016 was one of the first times since the mid-1970s that new dwelling supply has actually matched demand.”

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He says further apartment development will be essential to accommodate a rapidly growing population. “In our lifetime, we’re looking at a doubling of Sydney’s population. All of the growth that has taken 200 years will happen again in the next 50.” 

In a city like Sydney, hemmed in by mountains and the sea, the only way to manage population growth is to increase housing densities.

“A detached house has a floor-to-space ratio [of house size to land size] of around 0.5 to 1, but apartment buildings can achieve yields from 2:1 to 6:1 – up to 14:1 in the CBD where height caps are larger. They’re the kinds of numbers we need to look at in the future,” Cirillo explains.

Housing market shifts

While Australians seem increasingly willing to compromise on space for urban amenity, affordability remains the key driver behind the turn to apartment living, says Peter Phibbs, chair of urban and regional planning and policy at the University of Sydney.

“If you gave most people a blank cheque they’d still choose a separate house,” he says.

While he believes the long-term outlook for the apartment sector is strong, he also says there could be some short-term weakness, particularly as banks become more cautious about lending to both developers and property investors.

“Smaller developers can’t get money, so that’s changing the market compared to 12 months ago. The banks can see we’re not miles away from the top, so they’re paying attention to construction finance.”

Bankwest, which is owned by Commonwealth Bank (CBA), pledged in February to exclude negative gearing tax breaks when assessing loans for investors. CBA controls about a quarter of the housing loan market Australia-wide, and about one in three investor loans.

If the market does stall, investors are likely to retreat, exacerbating any price falls. 

“Investors are the original lemmings. They rush into the market when the price goes up, then once the price goes over the top and they see a downward trend they’ll sit on the sidelines trying to pick the bottom,” says Phibbs. 

Adding to the pressure are the stringent bank restrictions on lending to foreign property buyers, combined with Chinese Government moves to restrict capital outflows.

“If your Chinese buyer can’t close on a building, you’re pretty cactus,” says Phibbs. “They pay a small 5 per cent to 10 per cent deposit, then pay out the rest when the building is finished. So even if [the developer has] sold the building out, if they’ve got a lot of Chinese or international investors in their building who can’t get finance, it could be a problem.”

However, he says the best indicator of demand is not the health of apartment prices – “they’re driven by investors who are speculating” – but the state of the rental market.

“If you go to and look at ads for inner-city apartments, you’ll see ads with 12 people in a two-bedroom apartment. So, yes, the demand is still out there.”

That’s an extreme example, but with SQM Research putting Sydney’s rental vacancy rate at about 2 per cent in January (3 per cent is a balanced rental market), Sydney’s apartment boom doesn’t look set to bust just yet.

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