July auction figures showed that, as expected,Sydney's housing market continues to slow. The monthly rate of growth in home prices fell around one per cent – from 3.1 per cent to 2.1 percent according to CoreLogic statistics.

National valuers Herron Todd White say that Sydney's five-year property boom for houses and units is running out of steam as lenders' demands for bigger deposits and higher borrowing costs begin to take effect.

"Sydney has property at a price point to suit many. But entry level pricing might not always suit the first home buyer's lifestyle aspirations, " said Kim Quick, NSW residential director.

Commenting on the findings by CoreLogic that over half of the mortgage demand for Sydney property in the month of April was from investors, Mrs Quick said: "It stands to reason that this important segment has had much influence on the overall position of the market."

Slowing though it is, Sydney’s property market continues to produce record prices, with the median house price now $1.18 million, according to data from Domain released in late July. Market analysts were somewhat surprised to see that unit prices grew at twice their growth rate during the June quarter, which was a clear indication that apartment supply is still lagging behind demand.

Sydney apartment prices jumped 3.2 per cent in the June quarter to $757,991, while houses grew by 1.6 per cent to $1,178,417, as shown in the latest Domain ‘State of the Market Report’.

BIS Shrapnel senior manager residential Angie Zigomanis was one of those surprised by recent unit price growth, saying it was “higher than expected” due to former house buyers opting for apartments: “The indicators are still solid for Sydney, it is still under-supplied and we don’t see the market tipping into over-supply despite the building [boom].”

The ABC’s Michael Janda said that recent housing construction data shows an apparent decline in demand:“ABS data [in July] showed a 2.4 per cent fall in the value of construction work done, led by a 4.4 per cent slide in new residential building and a 5.1 per cent slump in renovations and additions. This reinforces the downward trend in building approvals, which are off almost 20 per cent over the past year.”

He quoted the Australian economics team at global bank UBS that has already called the top of the property boom and sees the number of new homes across Australia dropping to around 170,000 at the end of 2018.

However, despite a slowing market there are very few analysts tipping anything like a price crash in the next year or two. A Fairfax media team of Jessica Irvine, Matt Wade and Ross Gittins concluded that we are unlikely to see a massive fall in prices unless there’s an economic recession or a large spike in joblessness.

The team felt it was more likely that the Sydney market will experience a period of price weakness. Matt Wade warned that this could have an impact on consumer spending and confidence:  "It may not be a crash, but even a period of stagnation can hamper the economy."

Alan Oster, NAB's chief economist, also believes the Australian housing market is entering a cooling phase after several years of very strong growth: "Affordability will be a major constraint" on the property market, particularly if weak wage growth persists and banks continue to tighten lending,” he said.

The NAB forecasts that house price growth will remain strongest along the eastern seaboard this year - with Sydney to see solid (but slower) price growth:  "These trends will broadly continue into 2018, with growth in Sydney and Melbourne returning to more sustainable levels," the bank noted.

The bank also said it expects Sydney units to do “relatively well” this year, but has lowered its earlier forecast on how much housing prices would increase due to "record levels" of apartment construction and moves to limit foreign demand for housing.

Writing in the Sydney Morning Herald, Bloomberg Gadfly columnist Nisha Gopalan warned that Sydney will soon feel the effects of a Chinese buyer withdrawal from the market: “Reflecting tighter regulations, China overseas direct property investment could drop 84 per cent to $US1.7 billion ($2.15 billion) this year and about another 15 per cent to $US1.4 billion in 2018, according to Morgan Stanley,” said Ms Gopalan.

“A strengthening yuan, along with China's One Belt One Road initiative that needs funding, will see many property deals dry up.”

BIS Oxford Economics managing director, Robert Mellor, agreed saying: “Overseas investors are now facing significantly higher taxes as well as maybe there's still restrictions upon funds being able to come into the country from overseas, or overseas investors being able to get local funds."

Changing preferences

A new survey conducted by online marketplace ServiceSeeking found that one out of three Australians no longer has the ‘dream’ of owning their own home.

ServiceSeeking chief executive Jeremy Levitt told Domain that rising house prices are changing Australian culture: ““Housing prices and living costs are higher than ever, making it more difficult for younger generations to buy a home. The whole perception of home ownership and its importance in our lives has changed.”

Meanwhile, a June survey from Mortgage Choice found that two thirds of Australians consider home ownership to be ‘something for the wealthy’. However, an earlier survey from the same company found that 86 per cent wanted to own real estate, and that an apartment was considered the ‘most likely’ type of property.

Between 2011 and 2016 greater Sydney added 64,300 flats and apartments to the city’s housing stock. They now form 28.1 per cent of all dwellings in the area. This trend is set to continue with about 70 per cent of all dwellings constructed in Sydney in 2016 classed as medium- and high-density.

So rapid has the rate of apartment construction been that Sydney now has more than 100 suburbs where at least half of the population lives in a flat or an apartment. The apartment-density crown goes to Sydney Olympic Park where 99.6 per cent of respondents to the 2016 census said they lived in a flat or apartment on census night.

This puts them just over the Sydney CBD (99.4 per cent) and Haymarket (99.3 per cent). In fact, there were 15 suburbs where 90 per cent or more of the residents said they lived in a flat or an apartment. 41 Sydney postcodes sited more than 10km from the CBD have 50 per cent or more of their populations living in a flat or apartment.

The ‘affordability barrier’

The shift to higher-density living is due to a number of factors, such as wanting to find proximity to employment, public transport, education, and of course affordability. A Reserve Bank paper published in June said the median prices for apartments are about 30 per cent cheaper than detached houses. 

Compass Economics chief economist Hans Kunnen told Domain’s Jennifer Duke that it was likely home buyers were opting for apartments instead of houses due to what he called the ‘affordability barrier’.

“People just can’t afford to buy a house … supply has been strong but demand is clearly stronger,” Mr Kunnen said, adding that he expects the trend of stronger apartment growth to continue for the next six to nine months.

Social researcher Mark McCrindle told the Sydney Morning Herald’s Matt Wade that a growing share of Sydney families with young children is choosing to live in a high-rise building rather than move to a detached house.

"That final ceiling for denser urban living is being broken as parents raise their children through the schooling years in apartments. We've seen that in Europe, we've seen that in some parts of North America and we've certainly see it right across Asia but we haven't really seen it in Australia. So, we are approaching new terrain there."

One interesting development in Sydney’s fast-changing housing mix is that for the first time ever it costs as much to rent an apartment in Sydney as it does to rent a house. The latest Domain ‘State of the Market’ report found that the median rental cost for both types of accommodation is $550 per week.

And even though we’ve built record numbers of apartments in recent years, rents rose $20 per week over the June quarter – a statistic that prompted Tenants Union of NSW senior policy officer Ned Cutcher to say we’ve been building the wrong kind of apartments.

“Development is driven by what investors want rather than what households need,” he said.

“Higher priced apartments are being built where traditionally affordable homes were, at increasing densities and this is what you get.”

Real Estate Institute of NSW president John Cunningham said that many older-style inner and middle-ring houses have been redeveloped into more expensive apartments, and now the majority of rental houses are older homes in the middle-ring and new housing estates on the fringe.

“There’s a massive shortage of houses leaving families no choice,” he told Domain’s Jennifer Duke.

Interest rates stay low

One market factor that always has the potential to affect both investors and owner-occupiers is a rise in interest rates. It has to come sometime – it always does, but at this point there’s no way of forecasting when it might happen.

The chief economist of UBS in Australia, George Tharenou, said home prices would remain flat next year, but “if you did have a combination of the RBA starting to raise interest rates on an outlook which is getting better, based on better jobs [numbers] and it intersects with a timing that foreign demand [for housing] is now starting to fall and banks continue to reprice mortgage rates you are running the risk of having a harder landing for the housing market."

ABC journalist and economist Ian Verrender, shared these concerns: “"A house price boom borrows growth from the future, and both NSW and Victoria will have to pay back some of that in the years ahead as today's housing prices gradually reconnect with reality."

The ABC’s Michael Janda’s conclusions were that, if everything that could go wrong does so suddenly in this year, consumers will spend less and unemployment will rise: “If people did start losing their jobs, they would be unable to meet their mortgage repayments, thus defaulting, causing losses for the banks, and with forced property sales driving prices even lower with the danger of a downward spiral.”

A July report from Deloitte Access Economics said that interest rates didn’t need to rise by much before it created "mortgage stress" in inner-city suburbs. "Interest rates are now a massively more potent weapon for slowing the Australian economy than they've ever been before," the report said.

"The Reserve Bank knows that, and so it will be taking baby steps as it increases the cost of capital once again."

Riki Polygenis, National Australia Bank's head of Australian economics says the RBA is unlikely to raise interest rates this year: "The RBA will still be wary of choking off the gradual recovery we're seeing through the non-mining economy, and they'd also prefer a lower currency," she said.

"So, rate hikes are still some way off and we don't actually have them pencilled in until 2019, with some chance of it being a bit earlier in the back half of 2018."

The California crisis

In case you hadn’t heard, California’s currently going through what is called there a ‘full-fledged housing crisis’ that has some similarities to the current situation in Sydney.  Median housing costs are high and there’s a serious lack of affordable housing for middle-class families.

As the New York Times described it: “The median cost of a home here is now a staggering $500,000, twice the national cost. Homelessness is surging across the state.”

In Sydney, we wouldn’t consider a $500,000 median price ‘staggering’ by any means, even when converted to Australian dollars, but for Californians it can mean living in caravans or commuting two hours each way to get to work. It also means that the state has to make a lot of urgent changes to even begin solving its housing problems.

For years the state has resisted the pressures of development. Governments of local communities, the equivalent of our local councils, have knocked back projects they felt were ‘out of character’ with their neighbourhoods, leading to a serious shortfall in new housing construction. The state’s government is now considering ways to intervene and get more of these projects approved and urgently underway.

Issi Romem, chief economist of San Francisco-based BuildZoom, a company that helps homeowners find builders, says: “To accommodate all those people you need to build a lot, and the state’s big metro areas haven’t [built much] since the early ’70s. To catch up, cities would need to build housing in a way that they haven’t in two generations.”

A rapid catch-up in housing construction is, of course, precisely what’s been happening in Sydney and yet, despite an unprecedented construction boom of our own we still have the same high median prices and a lack of affordable housing. Increasing supply isn’t the answer to everybody’s housing problems.

The NSW government is looking at a housing affordability plan that might enable people now locked out of the Sydney market to lease affordable housing on a long-term basis. NSW treasurer Dominic Perrottet said he’s establishing a working group that will consider ways to implement a ‘build to rent’ sector of property development in this state.

The ‘build-to-rent’ industry, already working successfully in some parts of the US and manyEuropean countries including Germany and Denmark, is where large investors or institutions build blocks of apartments to be leased on a long-term basis. Each apartment cluster is managed by a single corporate landlord.

 "Australians are renting in greater numbers and for longer periods. With this evolution comes the need for greater housing choice, housing diversity and improved security of tenure for renters," Mirvac chief executive Susan Lloyd-Hurwitz told the Australian Financial Review.

"Build to rent can provide secure, quality, long-term and professionally-managed rental accommodation in key urban locations providing people with this choice and security,” she said.

Who knows? The next economic cycle for Sydney property might just be driven by investment opportunities in affordable housing that would once again stimulate construction and lead to another boom that history shows is likely to happen almost as soon as the current one is over.

Sources:

‘NSW government to establish a build-to-rent property sector,’ Su-Lin Tan, Australian Financial Review, 12 August 2017

‘Plan could see renters settled for decades,’ James Robertson, Sydney Morning Herald, 12-13 August 2017

‘Sydney, Melbourne house price growth slows over month,’ AAP release in Sydney Morning Herald, 24 July 2017

'It All Adds Up' podcast episode 6: Five myths about the housing market busted,’ Fairfax media podcast, Sydney Morning Herald, 27 July 2017

‘The Cost of a Hot Economy in California: A Severe Housing Crisis,’ Adam Nagourney and Conor Dougherty, New York Times, 17 July 2017

‘Sydney apartment rents catch up with houses as experts raise doubts about ‘supply solution’, Jennifer Duke, Domain, 20 July 2017

‘High density Sydney: How your suburb rates, according to the 2016 census,’ Matt Wade, Sydney Morning Herald, 19 July 2017

‘Housing market sentiment falls in every state: NAB survey,’ David Chau, ABC News online, 14 July 2017

‘If disaster does strike, here’s how to get out unscathed,’ Jason Murphy, News.com.au, 5 August 2017

‘Housing market 'powder keg' could blow if interest rates rise,’ Michael Janda,
ABC News online, 18 July 2017

‘Sydney house prices jump again, but ‘days of double-digit growth are over’, Jennifer Duke, Domain, 20 July 2017

‘House price growth to slow further but not crash: UBS,’ Clancy Yeates, Sydney Morning Herald, 17 July 2017

‘Home ownership not a priority for one in three: Rising prices ‘changing Australian culture,’

Jennifer Duke, Domain, 9 August 2017

‘Sydney house and unit markets 'starting to decline' as tougher lending bites,’ Duncan Hughes, Financial Review, 7 August 2018

‘That whoosh? It's the Great Chinese Property Pullback,’ Nisha Gopalan , Sydney Morning Herald, 8 August 2017

‘Residential construction heading for 31pc three-year collapse,’ Michael Janda, ABC News online, 10 August 2017