Sydney apartment market has cracked

Prices are in free fall in significant parts of the Sydney apartment market. Expect this to have a nasty impact.

The repercussions of what has happened in Sydney will quickly spread to the rest of the nation.

Significant parts of the Sydney apartment market and the associated apartment land markets have cracked and are now suffering serious falls.

The level of decline is much greater than most were predicting three to six months ago. The repercussions of what has happened in Sydney will quickly spread to Melbourne, although the blows may not be as severe in the southern capital because apartments are already much cheaper than Sydney. Brisbane is already in trouble so may be insulated from further big falls.

On an off-the-record basis one of the most influential property analysts in Sydney is forecasting that the building rate of apartments in the city is set to fall by at least 50 per cent which will have a severe downward flow on to economic activity in Australia’s biggest city.

Banks will fudge the impact during the current reporting season but in six to 12 months they will be reporting a significant rise in their problem loans and losses — particularly if global interest rates rise on the back of US tax cuts. Those looking for a fall in Sydney dwelling prices will be cracking the champagne today but unfortunately the repercussions will be nasty so the celebrations may be short lived.

As readers know I have been warning the nation that our banking industry is undertaking a property credit squeeze on a scale not seen for decades. For the most part the regulators and the bankers are inexperienced and are operating in silos so have not understood the combined power of the weapons they are using. Many will be shocked at the results of their actions and by what is to come. In putting numbers to the extent of the fall readers need to understand that the cracking process has been sudden and parts of the Sydney apartment market and other Sydney residential property markets have yet to receive the impact. Many will not fall as much as the big Sydney apartment estate markets, which also led the rise.

If you want a headline figure, apartments sold as used apartments in the big Sydney apartment estates have fallen by at least 20 per cent. The fall rate for individual sales can rise to 25 per cent.

These are huge declines by any measure although in Melbourne 18 months after the 1987 share crash falls of 50 per cent were common.

However the price fall in new apartments bought either off the plan or as the developer sells a completed apartment are down in the vicinity of 12 per cent.

As I will describe later there are good reasons for the difference.

And so a hypothetical apartment bought by an investor or a residential buyer for, say, $1 million in the boom (most two bedroom apartments were selling for between $1.2 million and $1.4 million) is now selling for $800,000 — a 20 per cent decline. If I want to buy that hypothetical $1 million apartment off the plan or as a completed unit it would cost about $880,000 — a 12 per cent decline.

This week Australia’s biggest apartment owner and developer, watching the free fall stepped in and offered buyers with a 15 per cent deposit two year funding at 4 per cent. The offer covered both completed apartments and a guarantee of two year 4 per cent loans to “off the plan” buyers so they will have the funds to settle when building is completed. Presumably Harry Triguboff will borrow the money from his bankers, which are usually led by the ANZ.

The initial reaction to the offer has been from overseas Chinese who are embracing the finance offer.

The Parramatta skyline with Chatswood in the background.

A local investor buying an apartment from a developer not only receives the rent but also enjoys a big deduction for depreciation.

But very quietly in the last budget, Treasurer Scott Morrison stopped the deduction of depreciation on used apartments from July 1, 2017. That means that for an investor, a used apartment is now worth substantially less than a new apartment — hence the 20 to 25 per cent price fall which is greater than the new apartment decline. But the two markets are clearly linked and the investor in completing the purchase immediately has a paper loss. This can develop into a vicious circle, which is one reason why Triguboff stepped in with finance to try and stop a freefell.

The apartment land market in many areas of Sydney is in chaos. About a year ago prime apartment land in Sydney (with approvals) was selling between $350,000 and $400,000 per apartment that could be developed on the site.

Now anyone who bought that land would be lucky to get $280,000 and the desperation of highly leveraged selling and the lack of buyers can result in some land going for $230,000 per apartment — a fall of above 33 per cent. The losses are sickening. Again the great danger is that a vicious circle will develop, creating even bigger falls.

Let me set out some of the reasons why the market has cracked. Tomorrow I will cover will further detail of the likely repercussions.

● When Australians now go to their bank to get a loan to buy a property either to live in as a residence or as an investor the banks first apply a severe formula to calculate projected household expenses to estimate net income. And for those who say the bank formula estimate of living expenses is too high, the banks begin a detailed examination of their expenses often asking for receipts. The end result is normally a sharp reduction in what the banks are prepared to lend and that drives what potential buyers are prepared or able to pay. When I first discovered this process I alerted readers to the danger.

● The level of interest only and investor loans by banks has been capped by the regulators.

● Interest rates on investor loans were increased and these first three events created a vicious credit squeeze.

● Then on top of the credit squeeze came the elimination of deprecation on used apartments.

● Valuers have been cutting back valuations further reducing loan levels. The latest fall will cause these valuations to fall further — again there is a danger of a vicious circle.

● Incomes for or non public servants stopped rising and job insecurity increased. Potential buyers became more nervous.

● The number of overseas Chinese buyers of new or off the plan apartments was slashed because they could no longer get substantial sums out of China and the local banks verbal comfort that loans would be available was trashed. Many Chinese who wanted to settle their off the plan purchases could not do it. Harry Triguboff has already loaned some $400 million to Chinese buyers to enable them to settle.

● The NSW opposition is threatening the market with new rights for renters, which makes it dangerous for investors — particularly those who plan to start with an investor apartment and then live in it. They may not be able to get the tenant out.

● Similarly the Federal ALP is promising to disallow negative gearing on used residential properties further underlying the value difference between new and used apartments.

● Once the rising prices heat turns negative there is not only no urgency to buy but buyers dry up fearing further falls.

● Councils have carefully and deliberately increased the price of apartments by delaying approvals and by requiring underground parking. The state government required social housing. These and other measures, including an increase in profit margins have made the apartments unaffordable to vast numbers of middle income Sydneysiders.

● Young Sydneysiders began greater sharing of living space so lifting the number of people living in an apartment. This reduced the demand from what had been projected.

The fallout from this unbelievable combination of events will be dangerous for Australia. I will detail those consequences tomorrow.

Recent commentaries detail some of the trends that led to the fall.

Home building fears realised August 15

The disturbing sign lurking past the housing boom April 28

Dangerous cocktail threatens to topple the apartment market April 6

Lending restrictions squeeze housing market October 3

Home loan lying fuels explosive mix September 12

A grim property tale of two cities September 15