Is it time to buy CBD apartments?
03 Mar 2021

Following some significant reductions in asking prices, lower rental returns, and consequently falling investor demand for CBD apartments, some property investors are again considering investing in rental properties in the city precincts. 

Their likely aim is to ‘beat the system’ by paying discounted prices and achieving solid capital gains when the international borders are re-opened and external migration drives demand for rental apartments. 

However, RiskWise CEO Doron Peleg warns that "this may still be a high-risk endeavour, with potential issues over both the short and long term".

Short term risks: elevated dwelling supply

"The first risk is poor or immediate negative capital growth for rental apartments", said Mr. Peleg. 

Overall, there remains a relatively high level of supply of rental apartments, both of existing stock and projects in the pipeline. A prime example of high-supply area is Inner Melbourne with 12,521 units in the pipeline, representing a further 5.1 per cent increase to the established stock of units. 

In addition, there is a risk in relation to yet to be launched off-the-plan projects. This means that once demand for off-the-plan projects returns, it is likely that further new projects will be launched. 

Over the past decade, it has been shown that there was no shortage of investor stock residential units either near to or with quick access to the CBD. In many cases the feared oversupply risk has been realised, with a large pool of investors in new apartments experiencing both negative equity and serviceability challenges. 

Mr Peleg of BuyersBuyers.com.au has said that "the opportunity cost of buying an inner-city rental apartment could be high, as houses with similar prices, but in the outer rings or in popular regional areas, are projected to deliver materially stronger capital gains".

"Put simply, even if a rental apartment does not depreciate or deliver some positive capital growth, effectively, you are still losing, as your wealth could have been substantially higher if you purchased a house in an area that enjoys good demand" Mr Peleg said. 

Serviceability risk: low external migration 

COO and co-founder of BuyersBuyers.com.au Pete Wargent added that "another risk that investors should be aware of is cash flow, or serviceability risk. The decline in unit rents was largely concentrated around the inner-city markets of Melbourne and Sydney, contributing to city-wide drops of 7.6 per cent and 5.7 per cent respectively over the year. Unit rents also fell 4.6 per cent across the combined capital city unit market".

Mr Wargent added that "reductions in external migration will also have a negative impact on the demand for dwellings, particularly smaller rental apartments. The Federal government is expecting Net Overseas Migration (NOM) in FY21 to drop to -71,600 people for Australia's first experience of negative NOM since 1946. This negative trend is forecast to continue in FY22 and only return to pre-COVID levels from FY23 onwards".  

The reduction in overseas migration has and will continue to have an impact on rental apartments that have already experienced increased vacancy rates and lower demand from investors. A stable jobs market is fundamental in external migration decisions. Consequently, poor economic growth and a soft employment market will see the attractiveness of relocation to Australia decline in the short term, while border restrictions make movement logistically challenging. 

In summary, serviceability risk is increased (particularly in the short term) due to the combination of continued high supply of units, preference for houses in capital cities and regional areas, and uncertainty related to the rental demand largely driven by young renters and migrants.

Off-the-plan apartments: a high-risk endeavour

Mr. Peleg highlighted that "off-the-plan units carry a high level of risk mainly as buyers, including property investors, have shifted demand to detached houses. Uncertainty in relation to external migration further increases the risk".

Figure 1 – Units in the pipeline

City

Postcode

Units in the Pipeline

As % of Existing Stock

Sydney

2000

919

4.1%

Melbourne

3000

1,767

4.9%

Brisbane

4000

890

9.7%

Adelaide

5000

1,362

12.9%

Perth

6000

814

4.1%

Hobart

7000

224

9.6%

Darwin

800

1,204

31.8%


Examples of high-supply areas include: Inner Melbourne (with 12,521 units in the pipeline, a 5.1 per cent increase to existing stock), Sydney – City and Inner South (with 4,051 units in the pipeline, a 3.1 per cent increase to existing stock) and Brisbane Inner City (with 4,407 units in the pipeline, 4.7 per cent increase to existing stock). 

We have seen that these risks have already translated into property price declines in some locations, such as the Darwin SA4 with 5-year price reduction of -29.2%, Perth – North East with a 5-year price reduction of -24.9%, Perth – Inner with 5-year price reduction of -12.8%, and Brisbane Inner City with a 5-year price reduction of -5.7%.

Therefore, the risk of price reductions for rental apartments, particularly between the ‘contract date’ to the pre-settlement valuation at the project completion, remains relatively high.  

Long term risk: opportunity costs

Mr. Wargent of BuyersBuyers.com.au also flagged a longer-term risk of opportunity cost. 

"Due to the high transaction costs, units are held for a period that is usually longer than 9 years", he said, "therefore homebuyers need to take a long-term view to consider the costs of buying and selling and should also consider the best capital growth prospects over the appropriate time horizon". 

Over the long term, houses have delivered materially higher capital growth and total return (i.e., average capital growth and the average rental yield) than rental apartments, although units in some desirable areas of the mature capital cities have also performed well.

Figure 2 – 10-year price growth by area 

Capital City Area

10-year Price Growth

House

Unit

Sydney

64.0%

54.2%

Melbourne

56.8%

35.0%

Brisbane

19.6%

1.6%

Adelaide

21.6%

19.0%

Perth

-1.0%

-10.8%

Hobart

51.4%

45.1%

Darwin

-4.9%

-26.0%

Canberra

47.7%

10.1%


Figure 3 – 5-year price growth by postcode - examples 

Suburb

Postcode

5-year Price Growth

House

Unit

Melbourne

3000

21.2%

6.1%

Brisbane

4000

24.4%

-6.4%

Adelaide

5000

23.6%

-2.7%

Perth

6000

-4.0%

-14.2%

Darwin

800

-18.4%

-51.8%


Land scarcity and undersupply of houses in areas that have good access to major employment hubs, resulted in strong price increases of houses. 

In addition, houses are generally substantially preferred properties over units. 

Consequently, the ‘opportunity cost’ is high and homebuyers who buy a free-standing house in an area that enjoys good demand, is highly likely to enjoy substantially higher capital growth. 

Mr Wargent noted that capital growth has tended to be higher in landlocked suburbs close to employment opportunities, good school zones, transport links, and other amenities. Fringe suburbs tended to see more land release and a greater risk of underperformance Mr Wargent noted. 

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