Nowhere has the COVID-19 property pain been felt more keenly than in the residential towers of Sydney and Melbourne. While tenants are taking advantage, investors are taking a hard look.

Robert Harley | 23 July 2020

The inner-city apartment towers in Melbourne and Sydney, the icons of the last housing boom, are the hardest-hit sectors of the COVID-19 recession.

The Reserve Bank, at its July meeting, pointedly noted the “weak conditions” in the rental market, stressing, in particular, the “increase in the supply of rental housing in some areas” and the “reduced flow of new arrivals to Australia”.

Nowhere are those factors more at play than in the apartment towers of Melbourne and Sydney.

When the rent stops, and the banks revalue the apartments, a contagion effect could set in.

— Brian Haratsis, executive chairman at MacroPlan

Tenants able to take advantage of the opportunity have a windfall. Rents have been cut, better terms negotiated and moves made to bigger apartments at less cost.

For investors, it is a painful experience, but with parallels to the downturns in Perth and Darwin which followed the collapse of the mining investment boom.

So is it time to exit? I have canvassed the views of two real estate veterans, both leaders of national property consultancies: Brian Haratsis, the founder and executive chairman of property consultancy MacroPlan, and Scott Keck, the chairman of property advisers Charter Keck Cramer.

The size of the problem was outlined this week in the latest ANZ CoreLogic Housing Affordability Report, which found that rental listings had jumped by over 50 per cent in inner Melbourne and in Sydney’s city and inner south.

While demand drops, supply is increasing as apartments in Sydney and Melbourne near completion. Erin Jonasson

To put that in perspective, consultancy SQM Research estimates that the vacancy rate of investment apartments in Melbourne Docklands was a high 12.9 per cent at the end of June and a similarly high 13.8 per cent in the Sydney 2000 postcode.

ANZ economist Felicity Emmett said the extraordinary rise in vacancy was due to the hard-hit service economies in those regions.

“Nearly 40 per cent of people who work in accommodation and food services sectors rent and between the weeks ending 14 March and 27 June, 21 per cent of hospitality workers lost their jobs,” she said.

The fall in overseas migration, particularly of students, also contributed.

Many short-stay apartments could also be converted to traditional long-stay accommodation. However, except in locked-down Melbourne, those owners do seem to be redoubling their focus on domestic tourism.

As vacancies have soared, rents have weakened with ANZ/CoreLogic estimating that asking figures have fallen up to 7 per cent in sectors like Haymarket in Sydney and Southbank in Melbourne.

I think that is conservative. Sydney’s leading apartment developer, Meriton Apartment’s Harry Triguboff told me in June that he had cut his rents by 20 per cent from pre-COVID levels. Significantly he found tenants at the new level with 150 to 170 apartments leased every week.

Ironically, as demand drops, supply is increasing with more apartments due for completion in Sydney and Melbourne as the super-cycle sputters to its end.

In Melbourne, another 17,950 apartments are under construction within five kilometres of the CBD, according to global real estate group JLL. In Sydney, 12,200 apartments are still to be completed within 10 kilometres of the city.

You would think that those projects are headed for problems with forecast rents and values lower than expected and loan-to-valuation ratios less generous than in the past, but the fallout is likely to be less than many think.

Some of those developers had already switched their focus to the owner-occupier market, which remains solid. Others, if financially capable, are massaging the sales with incentives, such as rental guarantees, or assisting purchasers to exit the contracts in an expanding “nomination” market.

Nevertheless, Brian Haratsis, the executive chairman at property consultancy MacroPlan, predicts that the value of apartments in inner Sydney will fall by around 12-14 per cent over the next three years and in Melbourne’s Southbank by 18-22 per cent.

For Haratsis, those markets will suffer the most nationally. Cuts to interest rates and low stock levels will support many traditional housing markets, and the Morrison government’s HomeBuilder stimulus generating activity on the urban fringe.

With the migration pipeline turned off, and recession limiting domestic household formation, Haratsis estimates that significant housing demand will be “lost” over the next three years.

Ripple effect

In response, rental demand will fall and not only in the inner city towers.

JLL national research director Leigh Warner warns that the downturn in Brisbane city apartment rents last decade rippled outwards, hitting markets like Chermside and Mt Gravatt, as renters were attracted to falling prices closer to the city. He expects a similar phenomenon in Sydney and Melbourne.

Haratsis says that since 2015, one quarter of all off-the-plan sales have been valued on settlement at 20 per cent or more below the purchase price and have been supported only by the rental income.

“When the rent stops, and the banks revalue the apartments, a contagion effect could set in, breaking confidence in the housing market and setting a momentum for declining prices”, says Haratsis.

“When JobKeeper runs out, and bank loan deferrals are no longer on the table, there will be a real test of market confidence.”

Charter Keck Cramer’s Keck expects price falls to be locally focused and around 5-10 per cent

He thinks the most vulnerable housing is on the high-debt urban fringe, with, so far, “little reduction in property values for established houses and townhouses in inner and middle urban areas”.

Keck says many off-the-plan sales were supported by incentives like undisclosed discounts, stamp duty concessions, and furniture packages, which the valuers on settlement cannot consider and which account for many of the seeming price falls in off-the-plan stock.

He is also more sanguine about population fundamentals. He expects ageing demographics to help the apartment market and that post-COVID-19, immigration will be “strongly incentivised”.

And he is conscious of the wild cards that could change the outlook, such as control of COVID-19, improved relations with China, returned interest from south-east Asia and a rebound in international tourism, as well as those existing factors – the low dollar, low interest rates and government stimulus.

“The residential markets always bounce back to normality, usually much more quickly than projected,” Keck says.