VIC Excerpt from the 2014 January Market report

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A surprise high performer, Melbourne has risen strongly over the past 12 months. But does this recovery have legs or will 2014 bring a slowdown?

Melbourne’s unexpected strong performance during the past 12 months has caught many experts by surprise. Our experts forecast a stagnant market during 2013, yet Melbourne has turned around and tauntingly staged a median house price increase of 7.7% since the start of the year. This is a spectacular result considering prices dropped 7.1% during the previous year. Even more impressive is the fact that vacancy rates have been rising and new housing supply has been flooding the market.

Angie Zigomanis of BIS Shrapnel credits the low interest rates rather than the fundamentals for the surge in prices. “It reflects the better employment position of its population and increased buying power at the current lower interest rates,” he says.

Like Sydney, the strongest demand and therefore price growth were concentrated in the inner suburbs where the median house price rose 7%. The middle-ring suburbs also grew strongly, with the median house price jumping 6%.

“The Melbourne economy has stood up quite well over the last 18 months, despite losing some of its manufacturing base and not being exposed to the export market like other markets,” says Andrew Wilson, chief economist at Australian Property Monitors (APM). “A lot of this growth has come from construction, particularly CBD construction. That’s kept the Melbourne economy ticking over, but there are real questions about how sustainable the economy will be over the medium turn.”

What’s ahead for 2014

So, does Melbourne’s unexpected turnaround have legs or is it all downhill from here?

Reasons to be cautious

Our experts believe there are still many reasons to be wary about the prospects of the Melbourne market, despite its unexpected strength.

1. High level of new supply still in the pipeline
A high level of supply of new dwellings in the pipeline (mainly in the form of apartment completions) is still coming through, and this will prevent any deficiency in the Melbourne market re-emerging in the medium term, according to Zigomanis.

“The next 12 months is probably a period where, more so in the inner suburbs, you will start seeing a lot more apartment supply come online,” says Zigomanis. “A lot of the bigger projects will progressively get completed. These will add to the apartment stock. It will add to vacancy rates. They’re in the apartment sector only, so they will definitely have a dampening effect on the apartment market.”

This means that investors buying in Melbourne now should be prepared to hold on to their properties for at least a full cycle or two and not expect major short-term gains.

“The Melbourne oversupply will work itself off in time, but it does act as a bit of a limiter,” says Shane Oliver of AMP. “The Melbourne inner-city negative supply issue places constraints on the market. On the other hand, home building in Victoria has been such a success story for so long that this state lacks the same degree of upside seen in this sector nationally.”

2. Manufacturing sector still under pressure
Despite some easing in the Aussie dollar, the manufacturing sector, which the Victorian economy is highly reliant on, is expected to continue to face headwinds in the next two to three years as it faces pressure from the strong currency and slowing building activity.

3. Rebound is likely to be short-lived
Our experts also warn that the recovery in prices is unlikely to be sustained, thanks to the ongoing housing oversupply issues, weakening rental market and softer economic environment.

Harley Dale of the Housing Industry Association expects median house price growth to again slow dramatically as soon as interest rates start to rise. “The current rate of growth in property prices in Melbourne is probably not sustainable. You will see an easing in the rate of growth over the next 12–18 months,” he says.

4. Weak economy
The Victorian economy is set to under perform the national growth, and with that, higher unemployment is on the cards.

“There are a lot of sectors in the Victorian economy that are under pressure,” says Zigomanis. “We don’t have the big mining projects. We don’t have big construction projects like desalination plants. The big infrastructure such as the Mornington Peninsula rail link is probably past its peak employment stage as well. So a lot of these things will start to come off.”

In addition, the big apartment projects that have been sustaining employment will start to wind down over the next two to three years, which will end up pushing the unemployment rate even higher. “We think the unemployment rate will rise. It’s already high compared to the national level and we think it will tick over further,” he says.

5. Vacancy rates to creep up even higher
Zigomanis warns that vacancy rates are starting to creep up and there’s at least another year or two of very high levels of apartment completions. “This means that unless Melbourne gets a big shift in demand for apartments, it will be a tough environment for landlords who own new apartments or those who are competing against new apartments,” he says.

6. Foreign investors are artificially inflating prices
There is a lot of international investor movement into Melbourne property and some of the investment models there are not following normal supply and demand imperatives.

Reasons for optimism

If you have investments in Melbourne, don’t despair. Despite the negatives, there are plenty of reasons to be optimistic about the Melbourne market.

Population is set to continue growing strongly
Population is still growing very strongly in Victoria

“In the latest population data from the ABS, I think [Victoria] was the fastest growing state. It actually recorded its best figure for net interstate migration for I think a decade. So I don’t think it’s necessarily been the attractiveness of Victoria economically as a place to live but it’s the lack of other options to go to,” says Zigomanis.

The Deloitte Access Economics report also puts Victoria on the leader board in terms of population growth. “The state still remains the largest source of population growth in the country, with growth trends actually moving back in the state’s favour over the past eighteen months,” it says.

1. Room to catch up with Sydney
Andrew Wilson of APM sees more upside for Melbourne due to the fact that it still lags behind Sydney by a number of years. “Melbourne is still not up to where it was three years ago,” he says. “We should see growth in Melbourne over the next six months that is similar to Sydney.”

Wilson adds that there is certainly a trend of confidence in Melbourne that’s moving the market forward, but where it goes after the next six months will depend on the capacity of the local economy.

“There are real questions about how sustainable the economy will be over the medium term, and we need to keep an eye on that because there is a lot of international investor movement into Melbourne property and some of those investment models there are not following normal supply and demand imperatives.”

2. Lower dollar to benefit Victoria
Victoria’s exposure to ‘dollar dependent’ sectors such as manufacturing, dairy farming and the teaching of foreign students means the state is in line to benefit if the Aussie dollar falls further.

3. Big infrastructure projects underway
In addition to the $4.4bn Kipper-Tuna-Turrum oil and gas project, the $5.3bn Regional Rail Link from West Werribee to Melbourne’s Southern Cross Station is also underway, according to Deloitte Access Economics.

Road projects are led by the $980m Western Ring Road expansion. Meanwhile, funds have been committed to the $8bn first stage of the East West Link development, to connect the Eastern Freeway and Western Ring Road in Melbourne, according to the economic forecaster.

It also notes that there’s been some progress in the proposed second container port at the Port of Hastings, with an expected cost of around $12bn.
  • Other major infrastructure projects include:
  • $1bn 140-turbine wind farm near Macarthur
  • $1bn development of two inland ports at Lyndhurst and Altona
  • $1.7bn development at Collins Square
  • $1.2bn Emporium Melbourne project
  • $1.3bn Comprehensive Cancer Centre

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