An ill wind in Victoria

Whisper it, but Melbourne may be feeling the first gusts of a perfect storm that could and probably should lead to a major rethink about apartment living.  Perhaps it will just blow over but there are too many negative elements lining up for the signs to be safely ignored.

According to recent reports, they include negative equity in brand new apartments, an excessive proportion of tenants, a potential glut in apartment stock and a growing belief that too many Melbourne units are too small and not well-enough designed.

None of these issues are earth-shattering on their own but together they point towards a potential slump in rents and property values that will, with a little bad luck, come sooner rather than later.

So what are the problems? First there are reports that some off-the-plan apartments have turned out to be worth less when they were finished than what they cost when they were sold off a glossy brochure.

According to a recent report in the Australian Financial Review, values in Melbourne and Sydney are falling by as much as 20 per cent between placing a deposit and settlement on off-the-plan units.

The article quotes valuations specialist WBP Property Group that the values of more than 40 percent of apartments bought in our biggest cities are below the sale price at the time of completion, with ­two-bedroom apartments priced between $500,000 and $700,000 the worst hit.

Of course, that means 60 percent are still OK and the same article reports that apartments bought ­off-the-plan two years ago in the Sydney suburbs of Chatswood, Rhodes and Glebe, are attracting prices 10 per cent to 15 per cent above the original purchase amount.

There are developments in Melbourne that have enjoyed similar profits but the days of guaranteed price rise windfalls are long gone, not least because part of the “blue sky” element of off-the-plan apartments is factored into sale price.

Nevertheless, blueprint and brochure investors, especially those with self-managed super funds, are attracted by the thought of “free money”.  That includes stamp duty exemption, tax-friendly capital depreciation and low interest rates. The problems arise when they don’t do their homework on eventual values and rental income.

The second element in the gathering storm is the slowing down of some sectors of the property market. According to the Real Estate Institute of Victoria, median unit values in central city areas went up only 1.2 percent in the September quarter (compared to 7.6 percent for the year) and house prices flatlined with no rise for the quarter, having enjoyed a 15.7 percent rise on the year.  The bubble may not have burst, but it seems to be running out of gas.

Masking the problem is that fact that that certain types of units in some areas are booming while others appear to have bust. According to figures supplied by Australian Property Monitors, between the May and August quarters the median price of two-bedroom units across most of inner Melbourne city went up in value, including an 11 percent rise in South Yarra, but dropped in Docklands where prices went down by 5.3 percent.

Most significantly, one-bedroom unit prices dropped 7.4 percent in central Melbourne, while in South Yarra they only increased marginally in value. And it’s partly a perceived glut of smaller units that alarms some observers and forms the third storm front.

At the recent “City in Crisis” public meeting Leanne Hodyl, Strategic Planner at Melbourne City Council, said apartments were getting smaller and less diverse with half comprising just one bedroom, and less than 10 percent having three or more bedrooms.  She also observed that 40% of all apartments in Melbourne city are under 50sqm.

This skew towards smaller units clearly mitigates against the chances of families moving into apartments and pushes the sector even further towards single renters and often illegal short-term lets.

In the centre of Melbourne, tenants already outnumber resident owners by three to one, which is well out of whack with the average of 50 to 60 percent elsewhere. The problem for investors is that market forces work both ways.

If a tenant rents a sub-standard apartment at an inflated rent and something better and cheaper becomes available, they will move there as soon as their lease runs out.  The owner who paid too much for their investment unit, and therefore asks too much in rent, can’t simply sell out when tenants demand more bang for fewer bucks.

And having too few owner-occupiers creates another problem. With 75 percent of your residents unable to participate in the running of the building – and by definition, three-quarters of owners living elsewhere – there is less internal pressure to fix defects, maintain common property and uphold community standards.

If tenants aren’t happy in an apartment block, they tend to move on rather than complain. And as long-term tenants move to better-run buildings, the spiral of decline can be rapid and devastating. If the Sydney experience is anything to go by, over-crowding, hot-bunking, internal subdivisions and short-term lets take over, giving the “good” renters even more reason to leave.

So how serious is this threat?  Right now in some inner Melbourne areas, vacancy rates are reportedly as high as 8 percent – way above the 3 percent comfort zone for a healthy rental market – and yet plans for more than 20,000 apartments have been approved in the immediate future with a further 60,000 in the next 15 years.

Add into the mix claims that the building and architectural standards of some Melbourne high-rises wouldn’t be allowed in other world cities such as Hong Kong and London and you can see why the well-worn phrase ‘slums of the future’ surfaced at the City In Crisis seminar.  And while Melbourne apartment blocks are far from Dickensian despair or Third World shanty status there is a growing sense that things are badly out of kilter.

The key may be to make apartment living a more attractive proposition for resident owners but they are very different animals from speculative investors.  They don’t get negative gearing or any of the other tax benefits so they want a reasonable lifestyle to go with the convenience and security of living in an apartment.

The major shift will occur when investors – who may never have set foot in their unit – ask themselves “would I want to live here?”

That could be a painfully valid question for some if they have miscalculated so badly and their negative equity is so severe that they have to sell their family home and move into the unit they had planned to let.