Over the past few years, the Australian property market has seen a pronounced disparity in price growth between houses and units.
Historically, houses have always commanded higher prices and demonstrated superior value growth compared to units.
Data from the last four years confirms this trend overwhelmingly.
However, recent developments indicate that this gap may be narrowing in certain regions due to affordability constraints and borrowing capacity reductions following significant interest rate hikes since May 2022.
A Look Back: Pre-Pandemic Price Gap
Eleanor Creagh, senior economist at PropTrack recently wrote that back in March 2020, just as the pandemic started to unfold, the median price difference between houses and units in capital cities was a modest $85,000.
Fast forward to June 2024, and this difference has ballooned to an astonishing 47%, translating to a price premium of over $300,000.
This dramatic increase underscores the substantial growth in house values compared to units.
Inner City Price Dynamics
The trend of house prices outpacing unit prices is even more pronounced in inner city suburbs according to Creagh.
In Sydney, for instance, the median house price in an inner-ring suburb is now more than twice the price of a median unit, creating a staggering gap of over $1.5 million.
This surge in the house premium was significantly driven by the pandemic, as people sought more space, took advantage of record-low interest rates, and had the flexibility to live further from city centers.
Growth Trends: Houses vs. Units
Since the onset of the pandemic, house values have surged by 47.7%, whereas unit values have grown by a more modest 23.9%.
This rapid growth in house prices was temporarily checked during the early stages of the rate hiking cycle, but the gap between house and unit values has since rebounded to a new record high.
Since the start of 2023, as the housing market began to recover from the sharp declines of 2022, house values have risen at a faster pace than unit values.
Regional Disparities
Since March 2020, capital city house values have increased by 44.2%, in contrast to a 16.8% rise in unit values.
The largest gaps between house and unit value growth have been observed in Sydney, Perth, and Adelaide.
However, recent data shows that unit values in capital cities have started to grow at a faster pace than houses over the past quarter, indicating a potential easing of the trend seen over the past four years, depending on the price points.
Affordability Constraints
Despite the significant lift in home prices, affordability constraints are becoming more pronounced.
The PropTrack Home Price Index indicates that national home prices rose by 0.18% to a new peak in June 2024, marking 18 consecutive months of growth.
Prices are up 10.14% from their December 2022 low and have increased by 3.14% year-to-date, sitting 6.55% above June 2023 levels.
Borrowing Capacity and Demand Shifts
The substantial rise in interest rates has reduced maximum borrowing capacities by about 30%, significantly decreasing potential loan amounts and budgets for buyers.
This shift has pushed buyers toward more affordable options, often resulting in trade-offs between location and property type.
Consequently, cheaper homes and units have experienced stronger growth trajectories relative to their more expensive counterparts.
As I see it, moving forward more homebuyers and investors are going to trade backyards for balconies and courtyard as these will be a more affordable option.
In fact today most established apartments are priced considerably below replacement cost meaning they have substantial inbuilt intrinsic equity.
And with the cost of the construction of new apartments having risen over 40% over the last few years, the price of the new apartment developments that will come online will, in turn, pull up the value of established units.
Units vs. Houses: Regional Trends
Recently more affordable regions and property types have generally seen stronger price growth, with units recording particularly strong growth in areas where they present the steepest discount relative to houses.
For instance, in inner Perth and Sydney’s Ryde SA4 regions, where unit values offer an almost 70% discount relative to houses, units have grown at a much stronger pace over the past year than in regions where the unit discount is closer to just 20%.
In Queensland, Brisbane’s inner city, where median unit values present an almost 60% discount to houses, unit values have risen by almost 16% over the past year, compared to around 2% growth in regions with a closer unit discount of 20%.
Melbourne's Unique Situation
In contrast to the broader national trend, Melbourne has been the worst-performing capital city market in terms of growth since the pandemic onset.
The gap between house and unit value growth in Melbourne has not been as extreme as in other markets, with only Hobart and Canberra experiencing a lesser extension in the house price premium since the pandemic began.
Again, I see this is a substantial window of opportunity with the cost of many established Melbourne apartments significantly below replacement cost.
It has been estimated that new apartments in Melbourne are going to have to sell for at least 40% more than current market prices to make new projects financially viable, and these will only start coming out of the ground once established Melbourne apartments in increasing value substantially narrowing the gap in prices between established apartments and new ones.
What’s worrying is that the cost of new construction is only going to keep rising. Especially for medium and high density dwellings.
It's just a challenging stage of the property cycle we experiencing, but one that creates unique opportunity for investors with a long-term focus.
Factors Driving Demand for Units
Units typically offer a more affordable entry point for first-home buyers and investors, reflecting the pickup in demand from these buyer types often skewed towards lower price points.
Affordability constraints and lower borrowing capacities have diverted demand towards cheaper housing options.
Additionally, stronger demand for inner-city living post-pandemic, coupled with rapid population growth and the relative value units offer, are likely buoying buyer demand in these regions.
Creagh explains...
Apartment sales over the year to May 2024 have also taken up a larger share of total sales volumes than any year over the past 5 years, in every capital city.
The Road Ahead
With home prices expected to continue rising in the coming months, further home price growth will continue to pose affordability challenges.
The trend of increasing demand for more affordable units is likely to persist as buyers navigate the constraints of higher interest rates and reduced borrowing capacities.
And when the cost of new dwellings be they homes or apartments goes up, the rest of the market follows, since new and existing homes are close substitutes.
Secondly the increasing costs of new developments is slowing down the supply of new homes, as many builders struggle and many projects are not currently financially unviable.
Of course, reduced supply then puts even more upward pressure on existing home prices.
And prices will keep rising until something changes.
