Lots of bandwidth gets taken up these days with discussing what is or what isn’t a bubble.
Who cares, though, really, as long as you are making money?
I recall a conversation with my business partner in London some years ago about whether the London property market was possibly forming into a bubble or not.
I think our conclusion was something like…
Well, quite possibly yes it was, but were we really going to sit back and not participate in it? Pfft!
A financial ‘bubble’ can be quite a nebulous concept at the best of times, as underlying fundamentals ebb and flow over time, and the terminology is rarely used with much consistency.
For example, the “commodities price bubble” in iron ore and coal Australia, formed on the back of Chinese urbanisation, is now generally recognised as having been a bubble.
Yet the once-in-150-year surge in mining investment is nearly always referred to as the “mining boom” – not a bubble – even though investment has collapsed over the last four years and billions of dollars worth of capital expenditure would ultimately prove to be malinvestment.
Incidentally, I made lots of money from the mining investment boom, but didn’t time my exits all that well, and ended up giving a fairly painful share of the profits back.
Them’s the breaks – it can kind of go with the territory.
High rise bubble
China’s urbanisation has triggered a series of echo-booms in Australia, the most urgent of which right now is the high rise apartment boom.
Or should that be bubble?
Well, let’s put it this way:
Australia is the sixth largest country in the world at around 7.7 million square kilometres.
And contrary to popular opinion, Australia does not have a high urban population density, with our cities being comparatively spread out.
Who, therefore, really wants to live in a 60 square metre apartment on the 20th storey of a tower block in Australia?
Some people, perhaps, and probably more so over time due to Asian immigration.
But not that many right now.
It’s probably a bubble of sorts.
Ratios shifting (from Rotten to Vicious)
A quick disclaimer or two: some of the numbers below are based on my own projections, rather than actuals, but they’ll be pretty close to accurate.
And this is by necessity a macro post – sub-markets will of course behave differently.
While new apartments were selling like proverbial Sex Pistols singles through the mania of 2015, unfortunately the outlook for the supply pipeline is now starting to turn from Rotten to Vicious.
And it’s becoming apparent that the new apartment sector is ultimately destined for a shellacking.
In the June 2016 quarter New South Wales saw some 16,956 dwellings completed – inclusive of 6,578 detached houses – taking total annual completions for the state to above 52,000.
This means that after ten long years the ratio of population growth to dwelling completions has now slipped to just below its three decade average of 2:1.
There are some 73,648 dwellings under construction in NSW, meaning that the blue line will inevitably decline further through 2017.
That said, even if the construction industry operates at full capacity it will be basically impossible for the line to plumb the depths seen in 2004 unless population growth drops considerably (this can happen if the right circumstances prevail – in 2004 annual population growth in NSW fell to just 30,000. Today it’s more like 105,000!).
Although there is more data available than ever before, it seems that people’s memories are getting shorter.
Recall that after the 2000 Olympics the booming Sydney property market led to a huge surge in construction, interstate migration, an oversupply, high vacancy rates, and a decline in prices.
You can clearly see the impact in the chart above.
Through just about every Sydney cycle it’s said that the city is ‘full’ and that there are few places left to build.
And in fact is now actually close to being true in terms of worthwhile greenfield sites close to the city.
But higher prices and potential profits are a powerful motivator that will overcome NIMBYism every time until viable new apartment projects are magically discovered and then approved.
We’re not quite there yet, but eventually the market will be swamped with new high rise apartment supply based upon these numbers.
On this point, some people will say ‘I told you so’, and that’s fair enough. Some of them have been getting the market wrong for nearly a decade now, so I guess they’re overdue a win.
Moving on to less geographically constrained Victoria, it’s interesting to note that the long run average of population growth to dwelling completions is only about 1.5, which is much lower than in Sydney.
That is to say, Melbourne generally has delivered supply more freely than Sydney, in part because it can sprawl more easily at its city fringes.
Completions in VIC surged to an unprecedented 18,150 in the June quarter taking annual completions all the way up to a record high of 58,814.
Yet population growth has sped up all the way to around 115,000 per annum, meaning that even now the population growth to dwelling completions ratio remains fairly close to 2.
There are a further 66,671 dwellings under construction in Victoria.
The twist in the tail may be that while more people are generally expected (by me at any rate) to start leaving Sydney for Queensland at this stage in the property cycle, Melbourne has recently seen inbound migration from interstate rise to its highest ever level.
Despite masses of construction, therefore, Melbourne may yet see its population growth levels run even higher still, thus helping to absorb the new stock
In short, Melbourne is the population growth king, which could prove to be the market’s saviour.
Although not charted here, the population growth to dwelling completions ratio in Queensland sits at about 1.6, with completions now tracking fairly consistently at around 10,000 per quarter for the past six periods reported.
A final thought or two
Over the financial year to 30 June 2016, Australia saw the completion of just over 200,000 dwellings, taking the total number of dwellings up to 9,703,500.
After accounting for demolitions and stock obsolescence the increase in the dwelling stock – although huge in historical terms – was just a shade over 170,000 or 1.8 per cent.
The population grew by about 1.4 per cent or 325,000.
There are some other factors which make this cycle unlike any that have preceded it, including record high rise apartment construction, and huge demand for new dwellings from mainland China.
Many of these apartments are very small, and many arguably may remain empty.
These factors could mean that the dwellings constructed may each provide shelter for fewer persons on average than we have seen through cycles past.
For these reasons and others, demand will ultimately be more important than supply going forward in determining what plays out next.
When demand is red hot new supply gets absorbed with apparently consummate ease.
It’s only when demand for housing falls away that the true picture is revealed – and this is when I believe the weakest sectors of the market will at last be exposed.
This is what last happened in Sydney from around 2004.