A tale of two cities: The challenges of the Melbourne and Sydney apartment markets

In early 2010 the effects of the Global Financial Crisis set in motion an upturn in both the inner-Sydney and inner-Melbourne apartment markets. The lower level of construction instigated by the GFC in the latter half of 2008 constrained new apartment completions in both markets. This further tightened rental markets, which, together with the post-GFC fall in prices in 2008-09, resulted in rents and yields rising.

As the economic outlook improved over 2009-/10 (and alternative investment forms such as equities remained weak) investors began to flood the inner-Melbourne apartment market. Investor demand in Sydney also improved, albeit at a more modest rate.

Given the resultant increase in the pipeline of supply, BIS Shrapnel is asking if the conditions in the inner-city apartment markets remain conducive for the upturn in Melbourne to be sustained, and to create a further upside in Sydney.

In answering this question, analysis of the population profile of inner city apartment occupants is relevant. Looking at census data for occupants of inner-city apartments in both Sydney and Melbourne indicates the large majority can be divided into three categories:

• Students, with the growth mainly coming from overseas students.
• Young professionals, who are typically employed in white-collar occupations in the CBD or CBD fringe locations.
• Empty nesters, such as older singles or couples without children living in the family home.

The first two groups largely create demand for apartments as tenants, while empty nesters are typically owner-occupiers.

Demand for apartments from young professionals experienced a brief setback during the GFC as employment in the financial sector declined. However, this rebounded quickly as the recovery came through.

Student demand has weakened, although most of the reduction in overseas student numbers has taken place in the vocational education sector. Student commencements in the university sector have experienced a more moderate decline and, with major university institutions located close to the Sydney and Melbourne CBDs, the softening in student demand has been less pronounced. Consequently, tenant demand has remained relatively solid.

However, although off-the-plan sales have shown a post-GFC recovery, actual new apartment completions have fallen. The long lead time for an off-the-plan sale to result in an apartment completion means the effects of the GFC are still impacting new apartment supply. Apartment completions experienced a setback in Sydney in 2010/11, while in Melbourne the setback was seen a year earlier in 2009/10. (See Figure 1)

Given projects in the development pipeline – those that are currently under construction or on track to proceed shortly – will take some time to reach completion, new supply in 2011/12 will remain below the long term average in Sydney, and only just above the long term average in Melbourne. This will not be high enough to create a significant impact on vacancy rates, and the environment for pre-sales from this perspective will still remain relatively positive in 2011/12, particularly if the economic environment and confidence improves.

The challenge will emerge from 2012-13, as new apartment completions will rise well above the long term average in both Sydney and Melbourne, and this is where differences will occur across the cities.

Figure 1: Apartment completions, Inner Sydney and Inner Melbourne.

History and those in the pipeline

Source: BIS Shrapnel

The pipeline in inner Melbourne is much larger. Off-the-plan sales to investors have been much higher in Melbourne over 2009-10 and 2010-11. This has been driven by tight rental markets, but also the solid residential price growth during 2009-10. With most of these sales located in large scale high-rise projects, the completion pipeline extends not just into 2012-13, but also 2013-14. Indeed, apartment completions in Melbourne in 2013-14 are expected to reach a record level. This is based only on those projects that are already under construction or set to commence and could be higher if additional projects achieve enough pre-sales to proceed. 

The sustained high level of apartment completions will create pressure on vacancy rates and rental growth in inner Melbourne from 2012-13. While there could be pent-up rental demand still to be absorbed after years of undersupply during 2007 to 2011, this is not likely to be the case by 2013-14. With a possibility of oversupply, vacancy rates in Melbourne are likely to rise, with falls coming through in rents and, potentially, prices.

In contrast, new apartment completions in inner Sydney will have remained well below the long run average between 2005-06 and 2011-12. While recent pre-sales are underpinning a sharp increase in new apartment completions in 2012-13, we do not anticipate it will have a significant impact on vacancy rates. This is mainly due to the substantial latent demand created by the low construction of the previous years. As a result, further solid rental growth in Sydney is expected to come through, particularly with employment and income growth anticipated to pick up pace over 2011-12 and 2012-13.

At this stage, if only current projects under construction and those on track to proceed make it through to completion, supply of apartments in Sydney is projected to fall in 2013-14. However, further off-the-plan sales will result in more projects coming through to provide some upside to completions for the year.

Finally, unless a substantial increase in new supply comes through, it is likely that new apartment supply in inner Sydney will remain in deficiency. This will continue to maintain pressure on rentals and result in upward pressure on prices over the next two to three years.

Angie Zigomanis is senior manager of BIS Shrapnel.