Property Investment in Melbourne – A Potential Financial Disaster

Property investments in Australia have, with a few exceptions, been very profitable. Real estate prices have kept on going up and up. But there has a few exceptions, sometimes the developers have become too ambitious and built far too much. Gold Coast is one recent example of this. But the biggest bubble may be Melbourne and a collapse could spell financial disaster for many investors.

Melbourne has just got new residential zones. It looks like the new zoning will make it even more important to invest in the right parts of Melbourne. Most of the attractive suburbs in the middle ring, the area 5 to 20 kilometers from the CBD, have banned high-rise buildings. Actually, many of the expensive suburbs have limited almost all of their areas to two-storey buildings or lower.

This means that high-rise buildings are mainly limited to CBD and the inner suburbs, within 5 kilometers of the CBD. In essence, exactly the places there high-rise buildings have been developed the last few years.

Developers in Australia, and especially in Melbourne, have found a very profitable game, develop high-rise buildings with plenty of apartments and sell them off-the-plan abroad. In order to maximize profits, many are cutting corners, building small low quality apartments. Small is sometimes an understatement, some units have become extremely small with bedrooms without windows (which strictly speaking are not allowed to be called bedrooms) and mini-kitchens in hallways.

Docklands and Southbank have been well known traps for investors with enormous numbers of high-rise buildings and more high-rise buildings are in the pipeline despite that vacancy rates are getting towards ten percent. But many of the inner suburbs are now heading down the same path with plenty of new high rise buildings coming.

In the good old days, boom-and-bust cycles did happen but once developers noticed that it became difficult to sell new apartments they stopped building and after a while the oversupply had disappeared. Now the game has changed, some large developers have realized that they can sell off-the-plan apartments overseas. Needless to say, a huge market like China is very difficult to saturate. This has lead to a building boom in Melbourne.

It is a pity that projects with small low quality units are not stopped now when inner Melbourne has enough with apartments. The authorities are happy, after all a construction boom creates jobs and boosts the economy. Soon inner Melbourne may have a huge surplus of apartments.

The building boom in inner Melbourne has been going on for a few years. So far, the growing population has managed to absorb most of the new apartments but lately rents have started to move downwards. And more apartments are coming so it could very well end badly for investors with units in inner Melbourne. Already many of the inner suburbs are dominated by investors, in some suburbs investors make up more 70% of the owners of units. Most of the areas are in the inner ring of Melbourne as well as CBD itself.

Remember that it is home owners that push prices upwards, not investors, so suburbs dominated by investors typically perform below average. With gross rental yields just above 4% and sinking, you need a handsome price growth to justify investing in a unit in Melbourne.

But price growth seems unlikely given the huge number of units being developed. More likely is that prices and rents will start to decrease due to huge oversupply of units. This is nothing unusual, the same thing has happened on the Gold Coast and the Sunshine Coast. Developers simply built too much and the market more less collapsed.

But things could get much worse in Melbourne. Developers are still building, they can sell units to overseas buyers, for example in China. This means that the oversupply in Melbourne could very well become enormous, especially in inner Melbourne.

A prudent investors should be very careful with units in Melbourne, and avoiding units in inner Melbourne. If you don’t own any units in Melbourne, now is not the time to get started, even if you can get a nice discount. The risk of chronic oversupply is simply far too high.

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