Apartment oversupply will ensure recent gains not continue at same pace: DPN's Sam Khalil

GUEST OBSERVER

The property market always moves reliably in swings, peaks and corrections. Just like the stock market it can be fuelled by skittishness, nerves and sheer hype. When you add emotion to that, you get a dangerous mix.

A number of property experts, from Goldman Sachs, Merrill Lynch and the University of NSW and many others have all come out recently to warn of an oversupply of apartment products and a projected decline in demand. While Melbourne seems to be headed for a certain oversupply, Sydney is also in danger of falling down this path.

In such a fertile time for property investment how could this be? To understand this you need to comprehend the historic reasons that have led us here.

In the aftermath of the GFC confidence in the property market, in any market really, was at an all time low. It was extremely difficult for even some of the strongest property groups in Australia to get their projects up. Major lenders were very cautious and the whole market was flat and carefully ticking along. Land developers were actually trying to encourage people to buy blocks out in Western Sydney – which, only five years on, seems absurd now.

The real trigger that caused a turnaround was the last Federal election. This led to a feverish run in investor sentiment. A realisation dawned that it wasn’t the end of the world and that financially speaking. Australia had actually been in pretty good shape.

Sentiments quickly changed and this caused a sharp spike in prices. As everyone started buying land or apartments there was a massive price escalation. The problem, of course, is that it takes a while to get any stock on the market. Consider the general bureaucratic hurdles in getting a DA approval or land subdivisions.

The low interest rates, a relatively strong economy and the appeal of property (which has now overtaken the share market as a better place to invest cash) all served to create hype and euphoria. Add to this the average assets in Sydney and Melbourne being so much higher than in other parts of Australia, has allowed people to borrow off their equity and make big investments elsewhere. Then, because everyone has seen values increase quickly in a short space of time, this has led to a frenzy of buying and investment.

So a log jam of development submissions and big land projects from a few years ago is now bursting into fruition. The problem is that it’s now outstripping demand. A recent report by BIS Shrapnel has estimated that we’ll see almost  12,000 new apartments built in Sydney in the next three years. There’s still quite a waiting list in land out in western Sydney as this is now all that’s available in Sydney.

The big problem has been buying the wrong kind of product at the wrong time. Specifically the mistakes made by investors has been mostly found in off the off the plan products. Developers are very good at feeding off hype. They will create the most gorgeously glossy brochures loudly broadcasting apartments that you can buy into, starting at only $700,000 for a one-bedroom apartment in Sydney.

But, as we often discover, that can mean you’re buying the worst apartment and the prices in the complex just start escalating from there. Many investors are buying believing the recent gains will continue at the same pace. What they risk is over-paying or buying at the top of the market and seeing their prices go sideways for many years. The climate is similar to 2002/2003 wherein Sydney had already seen an incredible run up in prices, when the market then peaked.

Sydney then had the worst property market for a decade, in terms of growth up to 2012. The last 3 years have been quite dramatic, yet it would be very foolish to pay record prices at the top of the market hoping that in 12-18months you will have made a gain. The opposite could very well be the result.

The other problem has been investors trying to get finance for off-the-plan apartments. Loan approvals only last three months yet the settlement may not occur for 12 – 18 months. In the background, APRA have been putting a squeeze on banks to slow down investor lending, so this too has a consequence.

So by the time the investor is ready for finance, the banks may reduce their initial valuation of the property and demand a higher deposit. For investors working with tight margins this can be disastrous. The investor is then unable to settle because they don’t have enough cash and the banks have valued lower. They default and lose their deposit and their property becomes another form of supply on the market.

 This then creates a perfect storm where values start dropping and the positive sentiment disappears. This has another consequence that with an oversupply of apartments (often negatively geared) there’s too much competition and so rents start dropping, which in turn pushes the investment downwards.

 So from a confident position of market jubilation it’s remarkable and instructive how quickly things can change. The key message is that it doesn’t matter how good the conditions are if you purchase the wrong product and don’t look at the bigger picture. Far too many first time investors make classic mistakes through eagerness and not talking to an expert.

It’s worth remembering that a market driven by hype will always be found out.

SAM KHALIL is founder and director of Direct Property Network.