A Tale of Two Cities: Melbourne property market to recover before Sydney

  • The property market correction has already pushed Sydney dwelling prices below their “fair value” levels, while Melbourne dwelling prices are now close to “fair value”
  • Sydney residential property: real prices to soften in FY2019; bottom out in FY2020; rise in FY2021
  • Melbourne residential property: real price decline half that of Sydney in FY2019; up by 2.4 percent in FY2020; plus 4.7 percent in FY2021

Sydney and Melbourne house prices will continue to fall further this financial year, before plateauing and then recovering over the following two years, according to a new report “Housing Affordability:Sydney and Melbourne market update by KPMG Economics, published today.

The new report is an update to a major study by KPMG Economics released in June 2017. It suggests widespread speculation that house prices are set to go into free fall is overly pessimistic.  While there will continue to be price declines in the near term, KPMG expects prices to bottom out in Australia’s two major cities in calendar 2019. The market will then start to see price growth again in Melbourne during 2020 and Sydney in 2021.

The KPMG Economics housing affordability update reiterates KPMG’s view that there is a long-run relationship between house prices and a batch of variable ‘push and pull’ factors relating to the stock of dwellings, population and borrowing by residential property investors. Despite short-term dislocation, prices tend to revert back to the equilibrium suggested by the long-run relationship over time.

“Our housing update shows that the tougher regulatory actions and taxation measures by both federal and state governments we identified last year have had a significant effect,” said Brendan Rynne, KPMG Chief Economist. “There has been a falling-away in foreign interest, notably from China, and lending to domestic buyers has got stricter, while housing supply has increased. This is why prices have declined – but we believe that process will reach its peak over the next few months and then go into reverse later this year.”

Mr Rynne noted: “In our 2017 paper, KPMG assessed that by the end of FY2016, house prices in Sydney were more overvalued in relation to their “fair value” compared to Melbourne, and therefore they were expected to fall by a greater extent. That has proved to be the case. Two years on, a relatively high level of increases in the stock of residential dwellings in both Sydney and Melbourne, a decline in financing for housing investors, and the tightening in APRA lending standards have all combined to drag house prices downwards. But what we have also found is that dwelling prices in Sydney are much more sensitive to the demand created by domestic investors than dwelling prices in Melbourne. It is predominately this factor that is causing the difference in expected dwelling price growth between the two markets.”

One element that is different to KPMG’s previous report is the explicit inclusion of the number of foreign students studying in Australia. On the basis that most foreign students would return to their home country for the extended summer break, and possibly for the mid-year break, their stay in Australia over a 16 month period is likely to be 10 to 11 months, and therefore they would be excluded from the ABS estimated resident population (ERP) statistics.

Mr Rynne said: “With now more 800,000 foreign students studying at Higher Education, Vocational Education, Schools and ELICOS institutions in Australia, and even adopting a higher occupancy rate than the average per dwelling, the accommodation demand for foreign students would have been around 87,300 dwellings in Sydney and 78,500 dwellings in Melbourne in 2018.”

The KPMG estimates that in 2000 around 10 percent of the additional dwellings entering the property market were required to accommodate foreign students. However with the massive growth in international students studying in Australia, KPMG estimates that around 30 percent of the additional dwellings entering the market in New South Wales and around 25 percent in Victoria in 2018 were required to accommodate foreign students.

KPMG’s analysis also finds:

  • Tighter prudential controls implemented by regulator APRA in recent years to improve mortgage lending practices, including capping annual investor credit growth and limiting of interest-only lending, have helped contribute to the slowing in residential price growth. These new rules, combined with a proactive tightening in lending practices of mortgage providers has seen lending to investors as a proportion of total lending to purchase residential real estate fall from 39.2 percent in the June quarter 2017 to 32.6 percent in the September quarter 2018.
  • In terms of dwelling construction activity, 126,600 dwellings were completed during the last two years in NSW, an increase of nearly 27,500 (or 27.6 percent) compared to the previous two year period of FY15 and FY16. For Victoria, the total increase in dwelling completions was 130,700, although that represented a more moderate increase of 15.6 percent over dwelling completions recorded during FY15 and FY16 period.
  • There has also been a sharp decline in the number of residential properties purchased by foreigners. Foreign Investment Review Board (FIRB) data shows that just under 13,200 residential properties in Australia were purchased by foreigners during 2016-17, which represents a significant fall compared to the 40,100 residential properties sold to foreigners during the previous financial year. During the past two years the Chinese Government, through its foreign exchange regulator, has implemented a range of foreign currency controls and limits on its citizens.

KPMG Economics also looked at assumptions relating to the potential impact of Labor’s proposed changes to Negative Gearing and Capital Gains tax should it win the next Federal election.

“One factor that has not been explicitly considered in our modelling is the potential impact of Labor’s proposed changes to Negative Gearing and Capital Gains tax in the case of a change of Government,” said Brendan Rynne. “While it is not our normal practice to make any political comment, on this topic we recognise that to leave this issue untouched from a pure economics perspective is akin to finishing an exam and purposefully leaving the last few questions unanswered. Thus, we have broadly considered the core components of these proposed tax reform policies.”

They are:

  • Capital Gains Tax – reduce the discount from 50 percent to 25 percent across all asset classes.  No change to Owner Occupied dwellings.
  • Negative Gearing – investment losses can be offset against investment income only for all asset classes (i.e. can’t offset investment losses against labour income), with the exception of newly built rental properties where the current Negative Gearing arrangements will continue to apply (i.e. investment losses can be offset against all sources of income).

“We also understand that all existing investments will be grandfathered, although it is still unclear what the cut-off date for this will be,” said Mr Rynne. “From an investment market perspective it would seem these policies are unlikely to distort the investment mix decision based on existing settings (i.e., property versus shares or other assets), with the exception of investments made by superannuation funds who we understand will be exempt from these changes.

These policies could have some impact on investment in dwellings for rental purposes, especially in the short term, as it will take time for the developer market to produce new dwelling stock for tax approved investments. Overall, the policies proposed are sound, but their introduction would need to be managed carefully.”

For further information

Marjorie Johnston
KPMG Communications
0407 329 430
mjohnston4@kpmg.com.au

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