Broken apartment market has deep structural challenges

Melbourne’s apartment market has struggled through its hardest year on record but is set to bounce back, an independent research firm says.

Property advisory firm Charter Keck Cramer says 2024 was arguably the hardest year ever for the city’s new-build apartment market. “The new apartment market has broken down and there are deep structural challenges in Melbourne which have been exacerbated by the pandemic,” the firm’s latest State of the Market report says.

Chief among those is the dramatic increase in building costs since the onset of the pandemic, combined with extra taxes and charges imposed by Victoria’s revenue-strapped government.

Deep structural challenges in Melbourne were exacerbated by the pandemic.Credit: Chris Hopkins

The sharp rise in construction costs has led to a price gap between new and existing apartments of more than 30 per cent, severely undercutting the business case for developers to build and sell new units.

That price difference has put new apartments beyond the reach of what many budget-conscious buyers, weighed down by a cost-of-living crisis, are willing to pay.

The effect is being felt nationwide. Construction costs surged 3.4 per cent last year, according to the Cordell Construction Cost Index. Since the pandemic, they have gone up by more than 30 per cent.

Costs appear to be stabilising in Sydney, but apartment completions remain well below 10-year averages.

The NSW government’s “unprecedented” planning changes and reforms will help spur development, but the “swathe of new planning controls coming into effect has also created industry confusion (particularly in relation to affordable housing), and many developers are going back to the drawing board to re-think project direction,” Charter Keck said.

Established apartments and townhouses in Melbourne are undervalued by about 15 per cent, the research group says, and will need to re-price upwards by at least that amount to make new construction viable.

Analysts at global finance firm Citi said in a note to clients earlier this week that apartment and new home sales in Melbourne were flat for most of the big ASX-listed real estate developers.

“The overhang in Victoria is partly being driven by change in land tax regulation (which has resulted in higher stock for sale on-market), and partly by construction-related issues which have resulted in low confidence,” they said.

“We believe a return of demand in Victoria is key to overall recovery for the residential landlords,” Citi said. “We note that further rate cuts and/or alternate measures by government/lenders may be necessary to improve affordability and drive demand.”

Charter Keck said the off-the-plan incentives rolled out by the Victorian government last year have failed to show their desired effect. The government cut stamp duty for off-the-plan apartments, units and townhouses in an attempt to stimulate demand. Instead, buyer demand has been stagnant.

“In our view, 2024 was the trough of this cycle, and there are several metrics that will shift over the next 12 to 18 months, which will support an improvement across various submarkets,” the research firm said.

The city’s rental market is chronically undersupplied, and the pool of rental properties is shrinking more as investors, slugged with extra land tax, offload their properties.

“Rents will continue to increase given the supply-demand mismatch,” Charter Keck said. That, in turn, is likely to boost prices.

Building costs are stabilising, and Victoria has a deeper labour pool than many other states, along with more tier 1 and tier 2 builders, which will also work in the state’s favour. Just as importantly, interest rates are widely expected to fall further.

“Melbourne is considered significantly undervalued and is anticipated to go on a very strong run, which could start towards the back end of 2025 and into 2026,” the firm said.

But the supply of apartments across the country is going to remain at decade lows for the next three to four years, crucifying the federal government’s target of delivering 1.2 million new dwellings over the next four years to 2029.

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