NSW Excerpt from the 2016 January Market report

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All good things must come to an end as Sydney’s runaway capital growth finally slows. However, that doesn’t mean the party’s over entirely
 
There’s no doubt that Sydney, and NSW in a wider sense, has been the capital growth performer over the last two years.
 
The state is undergoing something of an economic renaissance, taking over the crown of ‘fastest-growing state’ from a Western Australia reeling from the mining slowdown. That economic recovery is down to one simple fact, says Deloitte Access Economics: low interest rates.
 
“Interest rates have helped move the dial for both housing construction and housing prices, and have had knock-on impacts on the state’s retail spending as well,” says Deloitte’s latest Business Outlook report.
 
For our money, there are a few other contributing factors as well. A bull stock market has propped up the NSW capital’s financial sector too – a major driver of Sydney’s economy, especially for wealthy Eastern Suburbs and North Shore professionals.
 
The fact that the NSW government has turned on the taps in terms of infrastructure investment – headlined by the WestConnex and NorthConnex road projects, the North West Rail Link and the long-anticipated Badgerys Creek Airport – has also given the First State’s economy a shot in the arm.
 
A thriving economy also means more jobs, bolstering the population growth rate as workers return from the resources states in search of employment.
 
Sydney
A low interest rate environment has certainly helped Sydney record a second year of massive gains by improving affordability enough to release plenty of pent-up demand for housing. CoreLogic
RP Data records growth of 14.4% for the year to October 2015, with year-on-year growth of 15.6%.
 
CoreLogic RP Data’s research director, Tim Lawless, highlights that Sydney property prices have increased by 49.6% since 2012. That’s a boom by anyone’s measure.
 
Much of that growth has been driven by investors, both domestic and overseas. Sixty per cent of the mortgages taken out in the last year have been for investment purposes, says Lawless, and that could be one of the keys to the Sydney market’s future performance.
 
“We are starting to see a reduction in the rate of growth, and clearance rates have settled back to about 70% from above 90%,” says Lawless. “Values won’t go backwards, but it’s likely they’ll fall back to a more sustainable rate below the 10% mark.”
 
New Australian Prudential Regulation Authority capital requirements designed to curb investment lending will be a major factor in this. Indeed, fears over interest rate rises by major lenders saw auction clearance rates fall to less than 65% in early October, spooking the market.
 
The rapid capital growth across Sydney has also seen rental yields fall to an average of 3.1%, making properties less attractive from a cash flow perspective. A higher number of listings – partly as a result of new supply coming onstream and partly as a reaction to the superheated market – is also likely to restrain capital growth, as buyers benefit from increased choice (and perhaps struggle with affordability).
 
All good things…
However, while all good things must come to an end, there’s almost certainly no chance of a crash. BIS Shrapnel’s Angie Zigomanis says that, even with the significant supply response in terms of new properties over the last few years, there’s no danger of an oversupply as Sydney has been plagued by underbuilding for years. AMP’s Shane Oliver agrees, saying it would take several years of building at the current rate to reach the point of oversupply.
 
Equally, interest rates are unlikely to rise until 2017 or 2018 at the earliest, meaning the spectre of mortgage stress and forced sales is unlikely to hit the NSW market.
 
Instead, we’re more likely to see a slower, more sustainable market – a market that “is going to be a bit more boring”, says Domain’s Andrew Wilson. That boring market is one in which rental yields are set to recover, though.
 
“The yield cycle is starting to bottom out, and the Sydney market is still significantly undersupplied in terms of rental properties,” says Wilson. “Rents are rising in Sydney, especially as investors start to pass extra costs on to tenants.”
 
The new properties coming onstream may not offer any relief for renters either. Many of these have been “snapped up” by overseas investors who “aren’t looking for a return from tenants”, Wilson says. Therefore, vacancy rates are forecast to stay below 2%, and potentially even fall below 1%.
 
Looking ahead
The short-term forecast may be sunny but not scorching for Sydney, but what about the medium and long term?
 
Oliver suggests the danger period could be if and when interest rates begin to climb in 2017 or 2018. Even so, Oliver suggests it could be a soft landing rather than a crash.
 
“Sydney is resilient; it’s set to remain as the strongest-performing state economically, with strong immigration flows,” says Oliver. “We’re likely to see more of a loss of momentum, rather than an outright crash.”
 
Another cooling factor could be a slowdown in population growth, as potential buyers and renters turn away from an increasingly unaffordable Sydney, relocating instead to Melbourne or even Brisbane.
 
Oliver adds that the “traditionally strong” market sectors such as the Inner West, North Shore and Eastern Suburbs are more likely to weather any medium-term downturn, as these demographics tend to be less leveraged. Western suburbs, meanwhile, could be hit harder by tighter lender requirements.
 
Century 21 executive chairman Charles Tarbey also identifies Sydney’s heartlands as the safest bets for 2016 and beyond – especially if buyers can secure houses with a prized land component, ideally in suburbs where medium-density housing doesn’t exist.
 
“The Eastern Suburbs, Newtown and Petersham, the bay areas, and the Lower North Shore will all remain strong,” he says, “especially where there is a shortage of bigger properties.”
 
BIS Shrapnel’s Zigomanis suggests the Hills District will continue to outperform, particularly in zones where developers are keen to capitalise on the North West Rail Link. However, OnTheHouse.com.au’s Eliza Owen is sceptical about the long-term potential for that part of Sydney, suggesting that investors should carefully research long-term precinct development plans and local employment opportunities before committing any cash.
 
Regional NSW
Sydney’s runaway growth is also having a knock-on effect in regional markets – not least Sydney’s satellite markets, like the Central Coast and Wollongong, as cash-strapped buyers seek more affordable properties still within commuting distance of the capital.
 
However, the biggest opportunities lie in the markets along the coast, particularly the Tweed Coast and the Far North Coast.
 
“Sea changers and retirees are back in the market,” says Lawless. “Their plans may have been put on hold since the GFC, but it’s finally happening.”
 
Every one of our panel of experts named places like Coffs Harbour, Port Macquarie and the South Coast as areas set to benefit from retirees cashing in their topped-up super funds, plus the profits from selling McMansions to developers in Sydney.
 
A population of wealthy seniors means facilities to service their needs, boding well for local employment markets – not least the healthcare sector – and the low dollar should also help boost the tourist trade in coastal locations.
 
The upside is significant, says Angie Zigomanis, especially as most of these coastal towns have been weak for several years. The upgrade of the Pacific Highway will also assist Far North Coast locations, especially as it will improve transport links to Brisbane and the Gold Coast as well as Sydney.
 
Andrew Wilson highlights Byron Bay and its hinterland – a favourite coastal retreat for wealthy Sydneysiders – as an area where values are already rebounding. He suggests other coastal resorts could follow in its footsteps.
 
But Lawless suggests being wary around regional areas tied to the resources sector, notably Upper Hunter towns like Muswellbrook. “However, more diversified centres like Orange and Dubbo should be OK; their economic bases are better protected.”
 

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