I’m warning you in advance… You could lose money in real estate if you buy a brand-new apartment in the CBD.
Ok, I’m generalising a little here of course. You can still find value in any market if you buy well and if you’re a developer, you’d be loving the CBD market right now.
Here’s a few quick examples…
A friend of mine, who's name I can’t mention, bought a CBD development site in 2003 for $28 million and flipped it in May this year for $78 million. Ok, it’s an 11 year period and he had to wait.
However, other developers are buying sites for $10 million, getting approval for a high-rise within 4-6 weeks and flipping those sites for $20+ million… and it’s happening a lot, especially in Melbourne and Sydney.
But these guys are not mere mortals like you and me, they have super powers… deep pockets and in most cases, can sit it out if it goes wrong.
The general population is being led like lambs to the slaughter into the CBD apartment market that is unlikely to grow for many years going forward.
Here’s my research on why I believe that is the case.
Inner city high-rises are looking shaky. It shouldn’t affect the market overall, since they’re driven by Chinese investors who have their own agenda. But it’s a trap for Aussie investors I’d be careful to avoid.
Last week, we had a look at some stories that some less than awesome apartment buildings were being hastily thrown together, and flogged off to overseas buyers.
While I’m sure it was an isolated incident, it does highlight some of the strange things that can happen when serious money is at stake.
And that’s the one thing we know about foreign, and particularly Chinese investment in Australia – there’s some serious money involved.
So we’ve got to be on the look out for take-the-money-and-run developers, and make sure we don’t stumble into the traps they’re setting for Chinese buyers.
But that’s not the only trap to watch out for in the money madness. When tsunamis of money like this come crashing down on our shores, market conditions can change very quickly. We need to make sure we’re on the right side of market movements.
And since foreign buyers aren’t officially allowed to buy existing properties, we need to be watching the newly constructed market segment closely.
I’ve been doing just that, and right now, there’s some warning flags going up around Melbourne’s inner city apartment market in particular.
The first question I have is whether the supply coming on-line is properly suited to market demand. There’s been a lot of concern in public planning circles about the number of single bedroom shoebox apartments being added to the market.
The government is currently considering plans to ban micro-apartments and introduce mandatory design standards.
Normally, you can rely on the market to sort itself out. Suppliers have a good idea of what people want, and so will build accordingly.
However, that’s all getting confused at the moment because developers aren’t selling straight to the market. They’re selling through an intermediary – usually a Chinese investor. Thing is though, that that intermediary has no idea about supply conditions (design quality or market factors), or what Aussie consumers actually want.
The story last week shows just how these ‘blind intermediaries’ can get burned.
And it sucks to be them, but it can also introduce significant disruption into the market.
The second question is about whether the quantity of supply matches actual demand. If you look at the dwellings approvals data, there’s massive capacity coming online in the next couple of years.
It’s particularly pronounced in Melbourne. In Melbourne we’ve already built more homes this year than in all of 2013. When you add in homes under construction, it’s clear that 2014 and 2015 are going to be bumper years.
Most of this is coming from new high-rise developments going up in the CBD, Docklands and Southbank.
So it’s close to 12,000 homes in just two years. You can add to that approvals for another 19,000 homes from 99 separate developments set to commence construction in the next two years.
AND another 48 developments are currently seeking approval. They’d add 23,000 homes.
Of course, not all approvals become actual homes, but it gives you a sense for how much capacity is in the pipeline.
Overall for Melbourne this is a good thing. Melbourne has suffered from a supply shortage for years, and as the city grows quickly, the only way it can contain urban sprawl is to start building up its inner city areas.
But in the short term, the rapid ramp up in supply should be concerning for investors.
Because while Melbourne is growing quickly, it’s not that quick. In the short term, it looks like the inner city new apartment market, especially one bedroom apartments, is over-supplied.
That will probably lead to stalling or falling prices, and falling rents in that segment.
And we’ve already seen the start of it. According to RP Data rents have fallen 3.6% in Docklands and 6.4% in Southbank over the past year. They’ve been flat in the CBD.
Over the past five years, rents in Docklands have fallen 8.6%.
At the same time, prices are going nowhere. In all three areas, prices grew about 2% in the past year.
That might not sound so bad, but remember that Melbourne is currently booming. Prices on average are growing close to 12% a year.
And the prices of established units in established suburbs are going ballistic. In Collingwood, Glen Waverly, Malvern East and Camberwell, unit prices have grown over 20% in the past year!
This highlights just how distinct the apartment market is. Inner-city high rises are a completely different animal to established town houses or units in established areas.
Anyway, it all highlights how disappointing these growth rates are. If 2% is the best you can manage in a boom what might happen if things quiet down a little?
The thing is though, I don’t think this is going to phase the Chinese investors. Like the Chinese developers, they’re playing a long term game. Melbourne has to grow upwards at some point. They’re just getting in early.
And since one of the main motivations for investing in Australia is somewhere safe to stash their money, they’re not too fussed if yields are average or capital growth is poor for a few years. They’ll ride it out. They might not even bother trying to rent it.
But if you’re like me and you like investing for cashflow and capital growth, inner city high-rises will be a go no-where market for years.
(Sydney seems to be on the way there too – but it looks like supply doesn’t start to come online until 2016/17.)
Of course, I’m not writing of units altogether. Townhouses and small blocks in established suburbs will continue to attract a premium. A glut of one-bedroom shoeboxes doesn’t really touch this market.
But this Chinese-driven market will be sluggish for years. For leveraged investors who are dependent on cashflow and capital growth, it’ll be as dangerous as quick sand.
Don’t say you weren’t warned.