The main reason some segments of the Sydney property market will remain strong | Pete Wargent

Sydney has been the outstanding property market for the last few years, with 16% growth in the last 12 months.

But can this continue?  

Here’s why I think some segments of the Sydney property market will remain strong:

In 2009, Planning New South Wales released information highlighting its concern that dwelling completions were no longer tracking Sydney’s exceptionally and increasingly strong rate of population growth.

Planning NSW noted that over the 15 years preceding 2009, there had been three cycles of population growth and dwelling completions:

(1) in the first cycle, there was strong population growth and an equivalent upturn in dwelling completions;

(2) in the second cycle, both the pace of population growth and dwelling completions declined in concert; however
(3) in the third cycle from 2006 to beyond, it was noted that the rate of population growth boomed but dwelling production did not respond.

This upwards cycle in population growth was driven by a huge boost in net migration…

Rather than a shift in the natural population increase, which remained relatively steady:

In FY 2006/7, Sydney’s population increased by 63,000 with 29,000 of the increase accounted for by net migration. Yet by FY 2008/9 the increase in Sydney’s population had jumped to a staggering 85,400, the change largely driven by an increase in net migration.

This was not met with a meaningful dwelling supply response.

Population increase to continue for decades

The population of the Sydney region in 2009 was 4.5 million people which was 63% of the State’s population of 7.1 million. By 2036, pointed out Planning NSW, the Sydney region’s population was forecast to increase to 6 million which would increase its dominance of the State’s population to 66 per cent.

With the number of lone person households and couples without children having increased, it was forecast that Sydney would need 770,000 new dwellings by 2036. In spite of this, dwelling completions were only tracking at depressed levels as charted above.

Demographics and approvals

Immigration was forecast to be heavily focused on inner- and middle ring suburbs.

 

 But in spite of the pressing need for new dwellings, approvals fell away.

One of the main drivers for this was the unattractive return on investment for developers.

Dwelling prices had done almost nothing since the 2003 boom and with net profit margins so slender there was little incentive to build, particularly since construction and development costs had also leaped dramatically over the preceding 15 years, the reasons for which I detailed here.

With median unit prices now having increased to around $550,000 in Sydney, there is a decent amount of dwelling construction underway, particularly of multi-unit dwellings.

Australia-wide construction is on track to hit 180,000 commencements in 2014, the second highest level of commencements ever reported, behind the 187,000 hit in 1984.

But as evidence by the above chart, the margins are still too tight for developers to be particularly interested, and the situation balance remains fragile.

Today’s construction may result in the risk of oversupply of overpriced new apartments in a few Sydney locations and hubs.

I highlighted a few of the possible risk areas here, particularly in some of the new medium- to high-rise stock.

Supply issues to continue

However, dwelling commencements are forecast to tail off again in the coming two years while the population increase of New South Wales continues to stream into Sydney to the detriment of almost every regional centre in the state.[sam id=40 codes=’true’]

The major large cap developers – the companies with the resources and capital to resolve the supply issue – have shown very little interest in expanding their residential development plans dramatically, as can be seen on the respective company ASX releases.There is inadequate profit to be made to entice development.

Those working in the industry advise me that returns remain too low in the capital city residential development space, and thus the supply response is likely to dry up as soon as we encounter the next property price downturn.

Supply to fail to meet demand?

Reported the HIA , Australia needs to average 180,000 dwelling commencements per annum over the next 20 years in order to house its increasing population, but over the last 20 years we have averaged only 155,000 per annum:

 “This 180,000 is simply not achievable under the current structural barriers to new housing supply”.

The HIA cites disproportionately high taxes levied on the housing sector as a principal factor.

Other sources?

Other research houses have carried out research into the same topic and come to similar conclusion.

This includes ID, and you can download their eBook on the supply subject here.

ID also found that population growth would be focused in Sydney’s inner suburbs, with huge pressure on the inner west in particular:

One of ID’s interesting conclusions was that Melbourne has not struggled to bring supply online, the Victorian capital completing many thousands more units.

Melbourne’s problem has largely rather been one of bringing the type of supply online that people actually want to live in.

In both Melbourne and Sydney, only a minority of the new dwellings between 1996 and 2011 were located in inner suburbs.

I don’t know as much about Melbourne as I do Sydney, but I do know that in the New South Wales harbour city most people want to live near the beach and the city.

And, unlike Melbourne, Sydney just stopped building after its 2003 boom peaked leading to an utterly woeful supply situation unfolding and inevitably putting massive pressure on the market.

Summary

Since all of the above information has been publicly available and I chart it regularly, it was not difficult to predict that there would be no long drawn out property correction in Sydney in 2007/2008, since there was very little adequate supply and the population/demand was easily outstripping it.

It also wasn’t hard to predict that eventually prices in the most popular inner west suburbs would inevitably boom, if you were following the data in any way. That horse has now well and truly bolted with apartment prices jumping by 56% in only five years.

On the other hand, with plenty of supply and lower demand, it was also evident that affordable options would remain in outer ring and fringe areas, and indeed they still do: to the north-west, to the west and to the south-west.

There are also very affordable housing options to the north and south of Sydney. However, the respective transport connections to these locations are poor, and need to be addressed as a matter of urgency.

The fact of the matter is that a large part of Sydney’s supply problems revolve around far too many people wanting to live in far too small an area close to the city, and since that doesn’t appear likely to change, inner city prices appear likely continue to rise over time.



Want more of this type of information?


Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


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