Rising supply of apartments in Australia to pressure prices, especially inner Melbourne: Moody’s

Rising supply of apartments in Australia to pressure prices, especially inner Melbourne: Moody’s
Rising supply of apartments in Australia to pressure prices, especially inner Melbourne: Moody’s

An oversupply of new apartments in some regions in Australia over the next two years will pressure both real estate prices and rental returns from investment properties in these areas, says Moody's Investors Service.

The conclusions were contained in Moody’s report titled apartment construction Boom Poses Moderate Risk to Australian RMBS, which is based on the data in its supplementary excel report, Australian RMBS Exposure to Apartments in High-Density Regions. 

Around 230,000 new apartments are due to be completed across all the capital cities of Australia by 2018, according to Corelogic. This figure is more than double the annual average sales of apartments over the five years to April 2016. And more than half will be built in regions where there is already a large supply of existing apartments.

"Such a development will in turn raise the risk for residential mortgage-backed securities (RMBS) exposed to these 'high-density regions', but for Moody's-rated RMBS portfolio overall, the rise in risk will be moderate," says Natsumi Matsuda, an analyst at the credit rating firm.

"Specifically, with the Australian RMBS that we rate, there is a moderate overall exposure of 5.6% to mortgages on apartments in high-density regions," said Matsuda. 

"Furthermore, the risk posed to RMBS is mitigated by the level of equity that is available to absorb losses if borrowers default, as highlighted by the low weighted average loan-to-value (LTV) ratio of mortgages on apartments in high-density regions.” 

Exhibit 1 shows the exposure of the Australian RMBS portfolio to regions where, according to Corelogic, the largest number of new apartments is due to be completed over the next two years. The RMBS portfolio's largest exposures to apartments in these high- density regions are in the Sydney Inner City and Melbourne City regions, which are ranked first and third in terms of the areas with the most new apartments due to be completed over the next two years. 

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Rising supply of apartments in Australia to pressure prices, especially inner Melbourne: Moody’s

On LTV on mortgages in high-density regions, the current level is 62.5 percent, which drops to 47.6 percent after considering the increase in apartment prices.

Exhibit 2 below shows the five deals with the largest exposure to mortgages on apartments in high-density regions. In all of these deals, mortgage loans have low LTVs on weighted average basis, which means there is a material level of equity to absorb losses if borrowers default. 

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Rising supply of apartments in Australia to pressure prices, especially inner Melbourne: Moody’s

Exhibit 3 below lists the five deals with the lowest exposure to mortgages on apartments in high-density regions. These deals face the least risk from the increase in the supply of apartments in high-density regions.  

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Rising supply of apartments in Australia to pressure prices, especially inner Melbourne: Moody’s 

Melbourne suburbs have least additional equity to absorb losses

Of the high-density regions to which the Australian RMBS portfolio is exposed, mortgages in inner Melbourne have the least additional equity (7.6%) for absorbing losses, owing to the relatively low level of apartment price increases, says Moody’s.

Prices in the Melbourne City region have risen by just 5% over the last five years, compared with the 40% rise in Sydney apartment prices over this period.

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Rising supply of apartments in Australia to pressure prices, especially inner Melbourne: Moody’s

A relatively high proportion of mortgages on apartments in high-density regions are investment (46.5%) and interest-only (31%) mortgages, which adds to the risk, says Moody. 

Investment and interest-only mortgages are typically riskier than owner occupier and principle and interest mortgages, because, among other factors, borrowers typically repay loans slower and will therefore build equity more slowly. 

In the RMBS portfolio, the slower repayment of housing investment and interest-only mortgages is evident in the higher LTVs of these loans when compared with the overall portfolio, as Exhibit 5 shows. 

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 Rising supply of apartments in Australia to pressure prices, especially inner Melbourne: Moody’s

Furthermore, the large supply of new apartments due to be completed in high-density regions will put downward pressure on apartment rents in these areas and drive up vacancy rates, lowering the return for investors who rely on rental income to repay their housing investment loans. 

Rental yields on apartments in Sydney and Melbourne are already at the lowest levels in a decade. Such developments will in turn pressure mortgage performance.

 

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Rental Yield Apartment Market

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