COVID-19 is going through the Australian economy like a wrecking ball pillar by pillar, and the Melbourne property market will not escape unscathed. Our Melbourne property forecast sees a much slower market following the economic and financial headwinds facing the property market, with the overall Melbourne property market underperforming our Sydney property forecast.
Australia’s modern economy shifted away from manufacture to the provision of services. Melbourne is traditionally known as the industrial and manufacturing hub compared to Sydney but still maintains a large service sector.
The implementation of Covid shutdowns and social distancing designed (and worked) in reducing the coronavirus risks has disproportionately impacted the service sectors the most (tourism, hospitality and restaurants), which has an immediate impact on employment. The housing market will not escape unscathed from the impact of the shutdowns.
The recovery will be tough, and nothing like China’s experience after their reopening as the Chinese economy is still dominated by manufacturing, which can restart easier and faster. Even then, the experience is patchy at best.
The service sector being a large portion of the Australian economy means that the reboot post-COVID will be a slow L-shaped recovery spanning several years rather than a quick V-shaped recovery.
The Melbourne property market is not immune from the broader economic impact of the coronavirus. Property is not a haven port but will be impacted just as much as the rest of the Australian economy. Furthermore, Australia’s first recession since 1990 means there is a significant degree of leverage in the system.
During the GFC the financial and real estate sector was the ground zero of the crisis. The Melbourne residential property market was relatively resilient in contrast to commercial real estate (and unlisted property funds). But it will not escape unscathed this time. The industry will hit due to the second-order effects from the increase in the unemployment rate and decline in income levels.
The second order of effects will take time to take shape, and we outline a broad short and long-term impact of COIVD-19 based on experiences from other markets around the world.
Each part of the real estate market will be affected differently, but we highlight the significant trends we see that will impact Melbourne’s future prices.
Slow in Down in Melbourne Property Auctions
The auction clearance rate always gets the headline, but we always focus on the volume of transactions. The weekly number of auction slowed to a crawl during the lockdown period, and while it has trended back up, we still do not expect Melbourne auction volume to pick up in the near term. There is no pent up demand as the level of uncertainty from job losses will be a crucial driver in slowing purchases from now on.
Unfortunately, to add to this is an increase in listing from mortgage stress from the current and future job losses and will hamper prices. This will increase until the job market stabilizes and net jobs are created years down the track.
Tighter credit lending standards
Lenders (banks and non-bank lenders) have already tightened their lending criteria, limiting the available credit to fund purchases. We are seeing lenders pulling cashouts and redraws with new loans. Credit will still be available for those that are looking for a lower LTV loans i.e. (<70%).
Lender mortgage insurers, which are crucial in allowing banks to provide high LTV loans (85%+), are pulling back. The tightening of underwriting standards will reduce the availability of options for those who can buy but do not have the 20% deposits. Mortgages LTV in banks lending books will fall, but banks’ overall risk will increase as the extent of the bad debt charges are unknown.
The Australian banks are some of the most well-capitalized banks, but no matter how prudent they were pre-crisis, this will test their risk capital before we fully recover. We have always said the domestic banks’ biggest risk if there is a material rise in unemployment.
RBA can support the banks only so much, and their actions are more limiting the amount of damage than egging the lenders on.
We think this is the most significant risk in our list of risks in our Melbourne property forecast.
Melbourne Apartment construction will slow down.
An obvious third order effect of a slow down in volume and gradual decline in house prices will further reduce future supply. After completing the projects currently under construction, it will be tough for developers to start new projects as pre-sales and construction lending from banks will be hard to source. One spotlight is that non-bank lenders’ funds can potentially plug the gap, but they are still a tiny portion of the overall lending market.
Given the interlink of the sectors, this will further hamper construction jobs.
Impact on the Melbourne rental market
Depending on where you sit on the ledger, if you are renter, then there are some positives. Weekly rents will likely drop as units previously let as short term rental will come back into the market (conversion of previous AirBnB units back to long term renting). There will be less competition for rentals as demand for moving will decrease given the weak economy. There is also a higher degree of certainty in remaining in their current homes.
In the long term, there will be a structural shift following this crisis where a subset of people knowing that they could lose their job any minute will remain or convert long-term rentals from homeowners.
This will not just impact the residential market as the fall in the prices of the real estate investment trusts listed on the ASX show that the market expects rental and valuations to fall.
COVID-19 will impact Melbourne Property Prices
We see two main impacts on Melbourne property prices post covid. Melbourne apartments prices for units located in the Melbourne CBD, North Melbourne CBD and Docklands will slow. We expect the current projects under construction will be delivered, but no new projects will start in the next 24 months.
The critical question in the minds is how Melbourne house prices will react to the economic slow down from coronavirus? We think the risk will decline in house prices as the pressure from the pullback in buyers increases stock on the market.
The CBD apartment prices will struggle as Melbourne, and Sydney’s main difference is Melbourne has a lot more land to feed its growing population. Sydney is supply-constrained, with the only supply coming from apartments. The ample land supply means a broad housing boom is much more unlikely in Melbourne.
The following model is what happened to the Perth property prices after the end of the mining boom. The housing market did not experience a sharp drop like the fall in US house prices during the GFC, but a slow drip that will take years to play out. The slow recovery can be partly due to no massive force selling as seen in the US, with Australian mortgages being full recourse loans so people can’t just walk away from their obligations.
Landlord insurance providers have already reacted to the weak market by withdrawing landlord insurance on rental defaults. This is an example of a secondary effect of the slow down, but we feel there will be a lot more pain in the Melbourne property market in the next 24 months.