We are already seeing a slowdown in terms of new housing starts, however, the Australian market – unlike its foreign counterparts – has certain qualities that allow it to self-correct and adjust through a potential period of oversupply.”
That is the statement made by Group Managing Director Andrew Schwartz on behalf of Qualitas, a real estate investment management firm that believes the Australian property market is already in the process of a self-correction but its unique dynamics mean it will avoid a crash.
“National vacancy rates in residential property are sitting at a stable rate of around three per cent,” Schwartz said.
“However, we do see some warnings on the horizon for the short-term. This includes increased supply coming into specific precincts across Australia, rising site values, rising construction costs, lower levels of available construction finance and curbs on loans to foreign purchasers.
“Australia is no different to any other first tier global city in Asia, Europe and the US, in that there are substantial levels of new residential construction activity. A key difference, however, is the financing environment for these developments.”
The Australian construction finance market is predicated on the need to secure presales at a level that’s at least equal to 100% of the construction loan raised by a developer, before development can commence.
“This presale coverage ratio has been required by Australian banks for decades and has created a very prudent standard of lending. It reduces the risks of oversupply, thanks to the non-speculative nature of the sales commitment upfront. Moreover, the buyers need to be diversified, as the banks limit any one buyer from purchasing multiple apartments,” Schwartz said.
Foreign Buyer Risks Overstated
Another key distinction of the local market is the mix of foreign and local buyers, and although there has been a lot of concern expressed about the volume of sales to foreign buyers, Schwartz says the Australian banks – again, using very prudent lending standards – have insisted that a maximum of 30% (and often much lower) of total sales could be made to foreign purchasers.
“In addition, we know from our own experience that approximately one-third of all foreign buyers settle using their own cash resources. So, even assuming all the remaining foreign purchasers fail to settle – which seems a very harsh assumption – the banks will still have very comfortable levels of security.”
Forced Apartment Sales Not On The Agenda
Qualitas believes it’s highly unlikely that there would be a rush of bank liquidation sales for apartments, given the high level of pre-sales required upfront, the dominance of local buyers, and the banks’ conservative lending standards. While it is possible that a short period of market excess could appear, the firm continues to see the absorption rates being strong, as evidenced by continuing sales across well-designed projects.
“The demographics also continue to weigh in favour of residential apartments – including an ageing population seeking to downsize, an influx of offshore students, and continued high levels of immigration,” Schwartz said.
Short-Term Oversupply; Long-Term Shortage
Many of Qualitas’ own debt financing opportunities are for projects conceived in 2014-15.
“These ‘Vintage 2014 & 2015’ projects have undergone a long gestation period – from land acquisition, architectural design, planning development approval, securing pre-sales and, finally, obtaining finance. The Australian banks are continuing to finance well-structured transactions such as these ones, albeit at lower Loan to Value Ratios (LVR) than a year ago,” Schwartz said.
However, Qualitas notes, the number of new projects being conceived now – the 2016 Vintage –has substantially reduced.
Schwartz said the drop in new projects is due to a number of reasons, but mostly because site values have well and truly peaked, making development feasibilities harder to achieve.
“Coupled with higher construction costs and longer project timeframes, it’s hard to make the numbers stack up in the current environment. Given that we don’t expect a drop in construction costs any time soon, development feasibilities will remain challenged until there is confidence that apartment values will rise, and support the higher cost structures being encountered.”
Qualitas predicts that any excess apartment supply, if it exists, will be short-lived due to this lack of new projects.
“By 2020, prices will have risen, especially in Sydney and Melbourne, to support a new round of much-needed development projects”.
Opportunities To Invest Now
“When Australia is through the short-term turmoil of the existing market dynamics, and the longer term lack of supply is better understood, we will have acquired good property ready for development in 2020.”
Qualitas’ response to this market trend is to continue to find vintage 2014 and 2015 debt transactions and acquire physical real estate for repurposing.