Powerful demand remains, despite interstate exodus
16 May 2021

The VIC market has rebounded sharply. The end of the COVID-19 pandemic in Australia boosted sentiment in VIC, and the market is projected to deliver 8-12 per cent capital growth over the next 12 months, while demand for units is softer, especially in the Central Business District (CBD) and on the CBD fringe.

Houses in Greater Melbourne and the regional areas with access to the capital city enjoy strong demand, driven by ultra-low interest rates and strong buyer sentiment.

The Westpac-Melbourne Institute Index in relation to House Price Expectations has surged sharply in the past 12 months by 135 per cent. House price expectations are already being reflected in auction clearance rates figures, with final auction clearance rates in the first week of May 2021 showed results of 83 per cent in Melbourne. It should be noted, however, that a clear distinction should be made between houses and units. The average preliminary clearance rates for houses during the first week of May 2021 were 81 per cent, while for units only 66 per cent.

In addition to being a preferred dwelling option by owner-occupiers, houses are also perceived as a preferred a preferred investment alternative and generally carry materially lower level of risk than rental apartments. Consequently, the demand for houses is strong by both cohorts of owner occupiers and investors.

However, the current strong price growth rates are not sustainable and likely to be lower. Put simply, instead of extremely strong growth, we will likely see 'only' strong price appreciation. It is likely that supply will increase materially in the second half of the year, with vendors expecting to generate profit. In addition, higher prices make it harder for buyers to get the deposit and/or the required loan. Therefore, it is likely that auction clearance rates will also be a bit lower than they are now.

It should be noted that Regional VIC enjoys strong demand and delivered capital growth of 11.3 per cent over the past 12 months, substantially higher than Greater Melbourne with 2.2 per cent across the same period.

Houses

With only a low availability of stock of quality assets in popular areas across VIC, double- digit growth is likely for houses in Melbourne and in the popular regional areas over the next 12 months, with housing prices highly likely to break record highs.

Due to to lower-than-expected population growth, some greenfield areas carry a higher level of risk in the short term due to high supply. A prime example of this is Melbourne - West with an addition of 19,648 houses expected over the next 24 months, being an uplift of 9.2 per cent of the established dwelling stock. However, while the short-term risk is elevated, over the medium to long term no dramatic price reductions are expected and houses still present a lower level of risk than that associated with high-rise units.

Units

As with Sydney, a clear distinction should be made between family-suitable apartments and units in popular areas with limited supply of units, to areas with a high supply of rental properties.

Family-suitable apartments that are an affordable alternative to houses in the highly sought-after areas of Melbourne, such as the Inner East and the Inner South, are likely to enjoy good demand from homebuyers and solid price increases.

However, rental units in high supply areas, present a higher level of risk. Irrespective of COVID-19, many areas with oversupply have been labelled ‘danger zones’ and have low sales volumes. Examples include Melbourne – West with 4,354 units in the pipeline (8.5 per cent increase to the current stock), Melbourne – Inner East with 4,283 units in the pipeline (6.8 per cent increase to the current stock) and Melbourne – Inner with 13,399 units in the pipeline (5.4 per cent increase to the current stock). For these areas, the unit market will become less attractive than houses.

While buyer sentiment has improved substantially, the realisation of risks associated with high supply areas including price movements, constructions defects, and now high vacancy rates, make these properties, that are generally bought by investors, a higher-risk endeavour.

In recent years Melbourne has been the top destination for migrants, while interstate migration has also seen a net inflow to the state of Victoria. Internal migration swung away from Victoria due to the state's lockdown policies and related pressures, while the uncertainty surrounding external migration substantially increases the risk in the rental apartment segment, particularly in high-supply areas. The risks associated with these areas is likely to be mitigated over time with increased population.

Vacancy rates have noticeably increased in some areas, such as in inner-Melbourne, increasing the serviceability risk, particularly for highly leveraged investors relying on rental income and taxation planning to service their mortgage payments. According to SQM Research, vacancy rates for Melbourne reached 4.4 per cent in March 2021. In addition, unit rents in Melbourne have fallen -8.2 per cent since March 2020. The following SA4 areas have experienced large drops in rent: Melbourne – Inner, Melbourne – Inner East and Melbourne – Inner South. Mortgage arrears in these high-supply areas should be closely monitored.