Top 10 contrarian opportunities in Melbourne as house-to-unit price ratio hits record high

Melbourne unit prices have underperformed, but there are contrarian opportunities for investor.

Melbourne unit prices undershoot

Up until 2012 house and unit prices in Melbourne were tracking each other closely. But then a surge in high-rise construction led to a divergence over the past decade.

In fact, while the house price index for Greater Melbourne has increased by 223 per cent over the past 18 years, the unit price index for the city has only increased by 114 per cent over the same period.

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Figure 1 – Melbourne house and unit prices 2003- (indexed)

While not all units are created equal, we believe there are some opportunities for contrarian investors in Melbourne to buy investment-grade units in suburbs where is a high land value content in the asset.
Investors should look for a point of scarcity such as exceptional views, look at 3-bedroom units, or perhaps focus on another point of scarcity.

Population growth returns

More than any other city in Australia, Melbourne has been impacted by the absence of international students. A substantial number of young renters have entered the rental market, as the lockdowns encouraged more renters to find their own space at the earliest available opportunity. But the absence of international students has had an outsized impact on Melbourne’s rental market, but the situation will begin to normalise in 2022.

The absence of international students has had an impact on Melbourne’s rental market, but the situation will begin to normalise in 2022.

Now the borders have reopened further from February 21 and given that we have a backlog of two years’ worth of arrivals wanting to come to Australia, we can expect the bounce in rental demand to be strong.
Indeed, SQM Research reported a sharp drop to a 16-year low in the rental vacancy rate, driven by sudden sharp declines in Sydney and Melbourne in January.

People are returning to work now, and this tightening trend has continued in February for both Sydney and Melbourne. We can expect to see national rental price growth rising into the 10 to 20 per cent range forthwith, with most rental markets around the country already experiencing tight conditions.

Melbourne is going to take longer to see tight rental markets, with significant interstate migration to Queensland seeing the state of Victoria’s population actually decline through the pandemic, which was a very unusual dynamic.

Figure 2 – Rental vacancy rates in January 2022

Opportunities for contrarian investors in Melbourne

We are now seeing some opportunities in some markets for investors in apartments to experience capital growth and increasing rents, leading to strong total returns. The house-to-unit price ratio in Melbourne is at all-time highs, reflecting that affordability for houses is becoming a challenge for many investors.

The rental supply is unlikely to respond quickly enough to the surge in demand for rentals, particularly in an election year when there is inevitably going to be level of uncertainty created by a potential change in government.

Some of the trends created by the unprecedented border closures and pandemic restrictions will be transitory, and therefore investors should look through short-term noise to focus on long-term fundamentals.

Our analysis shows that there are some opportunities for contrarian investors in Melbourne apartments, with budgets of between $650,000 and $900,000.

SuburbSA4 regionPostcodeNumber of propertiesMedian unit price ($)12-month price growth (%)
ElwoodMelbourne Inner31846,850$719,37613%
PrahranMelbourne Inner32075,755$878,69212%
Port MelbourneMelbourne Inner31815,408$550,9597%
CarnegieMelbourne Inner South31636,341$646,9619%
Caulfield NorthMelbourne Inner South31614,567$718,38410%
MentoneMelbourne Inner South31943,593$703,11514%
Glen WaverleyMelbourne South East31504,302$882,44315%
KewMelbourne Inner East31015,036$834,15214%
Glen IrisMelbourne Inner East31464,683$746,8149%
Hawthorn EastMelbourne Inner East31234,658$695,0195%
Figure 3 – Top 10 suburbs for apartment investors in Victoria

Investors seeking long-term capital growth and strengthening rental returns should focus on certain opportunities as rents get set to rise. In the unit market there are opportunities for contrarian investors in Melbourne.

Vacancy rates in many of these suburbs are still above pre-COVID levels for now, and it may take some time for rental markets to tighten again. But the latest mobility data suggests that activity is picking up strongly in the city of Melbourne now, which is heartening to see.

Asset selection is especially important in these markets – investors should ideally look for more spacious, established properties, which may be more family-friendly. Generally speaking, we look for well-established, boutique unit developments with reasonable strata levies. And if the budget permits, look for family-friendly units with owner-occupier appeal, in those popular suburbs where the supply is somewhat capped.

Reserve Bank of Australia research has previously shown that new migrants and arrivals to Australia tend to have only a limited impact on the housing turnover rate, because most new arrivals are renters initially, especially international students.

That means far more demand for rentals is in the post in 2022. As the border reopens many parts of Australia may experience chronically tight rental markets. Melbourne may prove to have ample rental supply in the immediate term, but things will surely tighten up soon as population growth returns.

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