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Melbourne Apartment Supply demand to balance in 2022

  • Last week we had some investors question if we were being too optimistic about the potential supply deficit of new apartments in Australia in the coming 2-3 years.
  • There were questions regarding our exposure to Melbourne apartment developments which have seen the biggest demand “airgap” due to COVID-19 and net migration outflow (chart 1) which is causing pricing weakness.
  • Our current portfolio only has exposure to one Melbourne CBD apartment development which is due to be refinanced on May 30, however we are actively pursuing several residual apartment loans.
  • There is currently much more new development activation in Sydney, and this is reflected in new loans in due diligence.
  • With a scarcity of new off-the-plan sales and apartment activation in Melbourne we outline the case below that existing stock will be well absorbed over the coming years.

The latest Melbourne residential research from Charter Keck Cramer starts with the observation that, while residential markets began showing signs of recovery by the end of 2020, “the rising tide has not yet lifted all boats.”

The detached housing market has demonstrated a stronger performance, while the apartment market, particularly in the inner city, has suffered the most from the various impacts of COVID-19. Falling levels of overseas immigration and tourism caused demand for traditional and short stay rentals to plummet, at the same time as apartment completions remained robust. In Melbourne, for example, apartment rents were down 7% in the 12 months to December 2020 and vacancy more than doubled (from 2.1% to 4.7%).

CRE Lending Impact – Off-the-plan sales have been in steady decline since peaking in 2015/16. While owner-occupiers have benefited from low interest rates and higher rates of savings (enabling increased borrowing capacity and higher deposits) this has mainly supported the detached market, particularly due to incentives such as the Homebuilder grant. The average marketing period for apartment projects has increased from around 8 months in 2019 to 20 months in 2020, reflecting both slower sales rates and longer financing timeframes.

Demand – CKC expects underlying demand to decline from 57,000 in FY17 to just 30,000 new dwellings in FY21 due to lower overseas and interstate migration.

Supply – 16,400 apartments are due for completion in 2021, so the market is expected to remain soft. But from 2022 onwards, completions will decline significantly (3,200 apartments launched in 2020, the lowest in the last decade).

Composition of Supply –Within this decrease in supply, there has been an increasing shift to smaller projects in the Central and City Fringe areas, and the size of projects in the middle and outer areas have been increasing. This is contributing to 70% drop in the completions with the Central City, City Fringe, and Inner areas (from 11,800 in 2021 to 3,500 in 2023).

Outlook – The reduction in supply will provide some support on a medium to longer term view by helping the market to return to supply/demand balance, however the consolidation of the demographic shift in housing preferences may delay the recovery timeframe.

Implications for Partners Fund – Apartment construction currently represents under 5% of the Partners Fund exposure, compared to ~20% in June last year. The declining supply outlook will help ensure an improving supply/demand relationship, supporting valuations, while also implying a reduced number of opportunities in the sector. We anticipate closing several new construction loans in Sydney and Auckland residential markets in the coming months, however the focus in Melbourne CBD is currently on financing completed apartments.

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