Fears over an emerging property bubble in Australia have only intensified in recent months. Most of the attention has been reserved for Sydney, and rightly so. Prices in the harbour city have grown by almost a fifth in the year to June. No other city has come close to matching Sydney over the last five years.
Yet signs that Australia has become a two-speed property nation have been apparent for some time. Sydney and Melbourne’s growth rates have outstripped other cities ever since the mining bust started to drag on WA’s property market in 2012.
Both Melbourne and Sydney also have more diversified economies compared to rest of Australia.
In addition, migrants are flocking to Sydney and Melbourne in number far in excess of other cities. That, in turn, is pushing up demand for real estate.
While we’ve been transfixed by Sydney’s startling rise, Melbourne has flown under the radar. But perhaps it’s time we started paying closer attention to the Victorian capital. There are early signs that it could start to close the gap on Sydney over the next 18 months.
In the year to June, Melbourne property values rose by 10.2%, joining Sydney in double-digit growth territory. Granted, Sydney has grown by 16.2% year on year in comparison. At the same time, the June quarter saw Sydney prices grow by 3.1%, compared to Melbourne’s 1.9%.
But when we look at the data for the month of June, something interesting jumps out.
Dwelling price growth in Melbourne (2.9%) actually outpaced Sydney (2.8%) by 0.1%. That’s bucked the trend we’ve seen over the last year, where Sydney has dominated month to month.
What this suggests is that housing affordability in Sydney is finally starting to affect demand. Many would-be investors are being priced out of Sydney’s market.
The point here is that Melbourne has more room to grow, which could help it close the gap significantly over the next 18 months. With median dwelling prices of $560,000, Melbourne remains far more affordable than Sydney, at $722,000.
But does this actually suggest Melbourne prices could close the gap on Sydney in the medium term? Depending on the state of the economy, and RBA’s monetary policy, it’s possible.
The issue of interest rates is key here. Most economists are forecasting that rates will start to rise at some point in either late 2016, or early 2017. That would still leave anywhere between 12 and 18 months for prices to continue rising from their current levels.
We know for certain that RBA’s rate cuts are resulting in an uptick in property demand. But the importance of the monthly data for June suggest that the May rate cut benefitted Melbourne more than Sydney. Again, this ties in with housing affordability. As borrowing costs are lowered, demand goes up. But in Sydney, demand stemming from the average household may have reached its limit.
If that’s the case, then Melbourne’s more affordable prices could grow quicker in the next 18 months.
There’s a strong likelihood the RBA will cut rates again between now and 2017. We know this because the economy is still stuck in a rut. The temptation will be too strong for the RBA to ignore. If we look at housing affordability as a litmus test, then there’s every good reason to believe that Melbourne will benefit from it more than Sydney.
That said, this is a very liberal extrapolation of data at hand. The long term trends would lead us to believe that Melbourne can’t possibly reach Sydney’s level anytime soon. Since 2012, dwelling prices in Melbourne have grown by 26%, compared to 43% in Sydney.
That’s beside the point. It may not reach those levels, but it could close the gap between house prices in the two cities. Let’s say that Melbourne does end up closing the gap month on month for the next 18 months, even at marginal rates. That may still be enough to put it in dangerous bubble territory, especially if the economy entered a recession.
Houses price growth outperforms units in Melbourne
Across Australia, detached houses are proving more attractive, and lucrative, to investors than apartments. Nowhere is that more evident than in Melbourne. In terms of capital gains, Melbourne house values grew by 11.2% in the past year. At the same time, units were only up by 2.4% over this period.
This is down the fact that Melbourne has a problem with apartment oversupply. It’s not alone in that respect, but it’s feeling the effects of this more than other cities. CoreLogic data shows than one in four units sold in the March quarter went for an amount lower than the original purchase price. But it’s not hard to see why people are less optimistic about units. Just look at rental yields for apartments in the Victorian capital.
Melbourne has the distinction of having the lowest rental yields in Australia, at 4.2%. Granted, rental yields on houses didn’t fare much better. Melbourne ranks the worst in this category too, with yields of 3.1%.
CoreLogic predict that the pace of capital gains will continue to outperform rental growth, which may push yields lower by the end of the year.
Yet this also gives us another clue that Melbourne could continue to grow markedly over the next 18 months. The fact that investors are prizing capital growth over rental yields is telling in itself.
A strategy that opts for higher rental returns won’t provide the same capital gains when it comes time to sell. In other words, investors are prepared to negatively gear their investments because capital gains remain attractive.
Comparatively, Sydney’s higher rental yields could suggest that Melbourne price growth will match, and maybe even exceed, Sydney’s in the short run.
The property bubble may pop, but not anytime soon
In order for Melbourne to reach the dizzying heights of Sydney, it’ll need a few things to go in its favour.
We’ve already seen that the RBA is unlikely to raise rates until late 2016 at the earliest. Up to then, it’s easy to see them cutting the cash rate again to spur the economy. That leaves a worsening economic situation, which could result in higher unemployment, as the breaking point for house prices.
But that’s all speculation at this point. Other than that, we’re not likely to see a major correction in prices for some time.
In fact, as The Daily Reckoning’s property expert Phillip J. Anderson argues, the property market is only set to continue growing. He says that Aussie real estate will continue booming for another decade.
Phil’s 20 years of experience as a property analyst and advisor has given him a keen sense for where the property market is, and where it’s going. He correctly predicted the 2008 housing market crash. He also went against the trend in 2009, saying that house prices would go on to boom this decade. He was right on both accounts.
In his latest free report ‘Why Australian Property is on the Verge of a Decade Long Boom’, Phil guides you through this coming decade. He’ll show you the right time to buy property at its cheapest, and how you can use this to time your investments. To find out how to download his free report, click here.
Contributor, The Daily Reckoning