Inner Sydney Apartment Market Boom To Continue – For Now

By Bis Shrapnel on 25 Aug 2014
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Inner Sydney Apartment Market Boom To Continue – For Now

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Booming construction to reach historic levels, but supply pressures expected to emerge following peak.

The boom in the inner Sydney apartment market is expected to continue over the next couple of years on the back of buoyant investor demand, underpinned by low vacancy rates, the expectation of further price growth and low interest rates, says leading industry analyst and economic forecaster BIS Shrapnel.

According to its Inner Sydney Apartments 2014 to 2021 report, BIS Shrapnel says that high levels of off-the-plan sales in the next year to two years will continue, and drive further rises in new inner Sydney apartment completions to a historic peak by 2017.

However, this sustained level of additional stock has the potential to tip the inner Sydney apartment market into oversupply.

Investor Demand To Remain Buoyant

Senior manager and report author Mr Angie Zigomanis says that investor demand for inner Sydney apartments was initially driven by attractive yields in a low interest rate environment, but is continuing to be encouraged by the expectation of further capital gains.

“In the absence of any negative news in relation to the Sydney residential market, investor demand is likely to remain buoyant,” says Zigomanis.

“Vacancy rates will remain relatively tight in the short-term until the upturn in new construction translates to completions, while low interest rates and low or volatile returns for other investment classes are expected to continue to encourage investors into residential property.”

“Rising inner and middle ring Sydney house prices are encouraging some tenants to upgrade to larger apartments in inner Sydney…”

Demand from overseas investors is also expected to remain strong for now, with overseas buyers attracted by the stable economic and political environment of Australia, as well as the transparent property market.

Countries such as China and Singapore, which are attempting to cool their property markets by restricting local investment, are also encouraging this outflow of funds.

“To some extent, the inner Sydney apartment market is playing catch up after almost a decade of weak demand for new apartments and limited price growth,” says Zigomanis.

“However, the current surge in off-the-plan demand is likely to see the market get ahead of itself again as pre-sold new apartment projects commence and progressively work their way through to completion.”

New Apartments To Reach Peak in 2016/17

BIS Shrapnel estimates around 5,800 apartments in inner Sydney are currently under construction. Further projects currently undergoing marketing, or likely to go ahead, are expected to result in 11,500 new apartments being completed over the next three years.

While the anticipated peak of 4,500 apartment completions by 2016/17 is expected to be on par with the previous 1999/2000 peak, the average supply forecast of just over 3,800 apartments per year will be above any previous three-year period.

“Demand from overseas investors is also expected to remain strong for now.”

Zigomanis notes that occupier demand will also be recovering over this period. Overseas student enrolments are increasing for the first time since peaking over 2009 and 2010. Growth in long-term overseas visitor arrivals has also returned, while professional employment growth in inner Sydney is also expected to be relatively robust.

As most inner Sydney apartments are purchased by investors, these groups will contribute to increase tenant demand and help to fill up the new apartment stock.

Owner-Occupier Demand To Increase

Meanwhile, owner-occupier demand is also likely to grow. Rising inner and middle ring Sydney house prices are encouraging some tenants to upgrade to larger apartments in inner Sydney as owner-occupiers.

This is also encouraging empty nesters and retirees to trade down from their existing houses to apartments.

Nevertheless, says Zigomanis, this strengthening in occupier demand is not anticipated to be sufficient to keep pace with the record level of new apartments expected to be completed over the next three years, with vacancy rates forecast to rise in the coming years.

Rental Yields Expected To Decline Once Interest Rates Rise

Rental growth is likely to slow, but with further momentum expected in prices, rental yields will decline.

While declining rental yields are sustainable in the current low interest rate environment where the gap between rental income and mortgage repayments is relatively narrow, weaker purchaser demand and prices are anticipated to emerge once interest rate policy enters a tightening phase – with BIS Shrapnel forecasting the first rise in interest rates by the end of 2015, and further rises over 2016 and into 2017.

“The inner Sydney apartment market is playing catch up after almost a decade of weak demand…”

“Landlords of newly-completed apartments will have to be more competitive to attract tenants over existing stock, while owners of older apartments may have to discount to attract tenants from neighbouring suburbs,” says Zigomanis.

“The decline in rental returns and increase in mortgage servicing costs will reduce the amount the purchasers will be willing to pay for an apartment and many owners who bought at, or close to, the top of the market could experience losses if they sold into the downturn.”

Downturn Not Expected To Reach Mid-2000 Lows

Zigomanis says that the forecast downturn from 2016/17 will be relatively shallow, with vacancy rates not expected to reach the levels of the mid-2000s downturn following the last apartment market boom.

Therefore, any underlying excess supply should be mopped up relatively quickly, with an underlying deficiency re-emerging towards the end of the decade to underpin the next upturn in the cycle.

“Landlords of newly-completed apartments will have to be more competitive to attract tenants over existing stock…”

However, demand in the short-term for inner Sydney apartments is expected to remain buoyant, with low vacancy rates and low interest rates helping to fuel the market and drive median price growth averaging around six per cent per annum over 2014/15 and 2015/16.

This level of growth is expected to be ahead of the magnitude of decline in prices anticipated over the following two years, with the decline clawed back over the subsequent years as the market tightens again.

As a result, total price growth of around 21 per cent, or just under 3 per cent per annum, is forecast through to 2021.

About the Author

BIS Shrapnel is Australia's leading provider of industry research, analysis and forecasting services. BIS Shrapnel helps clients better understand the markets in which they operate, through reliable and detailed market data, analysis of developments and drivers and thoroughly researched forecasts.

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