“The population is bigger than we thought”

  • Most independent data providers and research analysts that Merricks Capital works with in the property sector have been expecting Melbourne apartment supply to finally surpass demand this year (2017).
  • Anticipation of a balance or oversupply in the apartment market has led Merricks Capital to focus on lower-risk senior lending as opposed to equity or mezzanine lending
  • More recently however, one of our data providers has begun highlighting that they have underestimated population growth and we suspect they will be the first of many to upgrade housing demand on this basis
  • The more positive outlook does not change our view that we need to be in the more conservative part of property investment at this part of cycle, but further adds to our view that senior secured lending against residential real estate offers exceptionally good risk adjusted returns

Doom and gloom

Earlier this year when BIS Oxford Economics released its “Residential Property Prospects 2017- 2020” report, the analysts forecast that a glut of apartments in Victoria would result in massive oversupply and falling prices across the property market. They saw median house prices rising just 5% (or falling 3% In real term) over the 2017-2020 period, while median unit prices were forecast to drop 4% (11% in real terms) over the period. These forecasts were based on the BIS estimate that Victoria had a deficiency in housing stock of just 3,900 dwellings in June 2017. With new supply of 63,200 expected to exceed demand of just 56,400 dwellings during FY18, BIS estimated the property market would move to oversupply of 2,900 dwellings over the year. While noteworthy, this was still an improvement over an earlier estimate in September, when BIS forecast an oversupply of 22,000 dwellings by next June.

The sky isn’t falling after all

While analysts can get a pretty accurate feel for new housing supply becoming available from a range of indicators such as building permits and dwelling commencements, the demand side of the equation is largely a function of population growth and accurate population data is published less frequently.

The latest release of data from the 2016 census has confirmed that population growth in Victoria was much higher than BIS previously expected. In fact, BIS recently told the Australian Financial Review that the new census figures showed Victoria had 109,000 more people than it previously estimated – or almost 35,000 extra households.

The additional population data has meant BIS has upwardly revised its forecasts for demand, resulting in a net 20,000 turnaround for apartments.

Strong population growth has been supported by record net interstate migration inflow, particularly as residents who had previously left for better employment prospects in the mining states of Western Australia and Queensland returned to their home state. Net overseas migration has also been strong, with growth from overseas students a key factor. Student demand now represents 27% of demand for inner city apartments, up from 20% five years ago.

The latest census numbers give a Greater Melbourne population of 4,485,211 in 2016, an increase of 485,529 people or 12.1% over the previous census population in 2011. This growth is higher than the national average and Melbourne now accounts for 19.2% of Australia’s population, up from 18.6% in 2011 and 18.1% in 2006.

Unsurprisingly, the number of dwellings has also grown at a faster pace than the national average. There were 1,832,043 private dwellings in Greater Melbourne in 2016, representing growth of 12% growth over the 5 years since 2011 or just over 39,000 additional dwellings each year on average. This compares to 8.6% growth in the number of dwellings nationally.

The conservative, and subsequently upwardly revised, forecast shouldn’t really come as a surprise. Forecasters such BIS are generally conservative cautious by nature. The following chart shows that national median house price growth has exceeded its estimates in most years (2008-2010 affected by the GFC), particularly since 2012. BIS has also forecast a decline in median house prices, which is yet to eventuate, in each of its last 4 “Residential Property Prospects” reports.


Not that this is a concern. “Conservative” is exactly what we want from BIS when it comes to forecasts for property prices, but the issues facing the market are not new ones and the threat of an “apartment oversupply” and collapse in prices has been flagged for some time.

The complete revised outlook for the property market, and the economy more broadly, is part of the BIS “Business Forecasting Conference” program currently underway. Ahead of the conference, BIS says it believes Victorian apartment commencements will continue to soften, more than halving from the 19,800 at the 2015 peak to just over 7,200 in 2021, not nearly enough to satisfy underlying demand growth.

Merricks Capital notes that the drop in apartment construction is partly in response to tighter credit availability. The major Australian banks have reduced their exposure to residential investment lending due to tighter macroprudential measures introduced earlier this year, including restrictions on interest-only lending and measures to limit growth in investor lending and ensure the serviceability of loans.

Merricks Capital’s CEO Adrian Redlich says that lenders have moved quickly due to the tighter measures and the construction response means that Melbourne apartment prices were likely to experience a “soft landing” as a result of the pullback in supply.

Mr Redlich says the void in property financing has provided a number of attractive opportunities.

Senior lending offers superior returns due to a lack of loan competition, while risks are limited due to the strong structural demand for property and low levels of leverage – or LVRs. “The upgrade to population estimates and reversal in supply dynamics highlighted by BIS mean we will likely avoid a significant level of apartment oversupply or price falls. This further reduces the risk in lending to quality property developments.” “The dislocation between risk and return has created a unique position for investors and we are actively pursuing a number of quality senior lending opportunities.”