WHY INVEST IN MELBOURNE?

By Victor J Nicholas

April 21st 2007

Why should you invest in Melbourne?

There is no definitive short answer to this question. However, there are a multitude of reasons why an astute investor would invest in Melbourne. Aside from the obvious visual beauty and the thriving sports and arts facilities that any Melbournian would happily attest to, there are demographic and economic factors that would appeal to even the most cautious investor.

Real estate investors in Melbourne should be aware that the prime reason for investing in property is capital growth, and capital growth is driven by the scarcity of an asset.

When selecting a property for capital growth there should always be a consistently greater level of demand than supply. In this report we will examine the aspects that are shaping supply and demand in the Melbourne property market at present and how the current trends will benefit the astute investor in the coming years.

Population Growth

One of the primary factors that make investing in real estate in Melbourne an attractive proposition is the fact that Melbourne is experiencing its biggest growth surge since the 1960s, with its population now increasing by almost 1000 a week and dwarfing that of any other Australian city.

Melbourne added about 49,000 people in the year to June 2006 — far more than Sydney (37,000), Brisbane (29,500) or Perth (30,000), according to the latest figures from the Australian Bureau of Statistics. 1

In the next 30 years, Melbourne will grow by up to one million people and will consolidate its reputation as one of the most liveable, attractive and prosperous areas in the world for residents, business and visitors alike. Housing demand will be boosted by the arrival of skilled foreign workers needed to offset the ageing population.

Rental Shortages

Another attractive reason for investors to invest in the Melbourne property market is the dearth of rental properties with the resultant vacancy rates hitting all time low levels.

There are a number of factors that contribute to rental shortages, but in the case of Melbourne The Age economics editor Tim Colebatch summarized the plight:

Rental shortages occur when construction does not keep up with the growth in demand. While Melbourne's housing stock has grown by more than any other city in Australia, so has its population. If only we now had those towers in Docklands, the CBD and Southbank that were swept off the drawing board in 2003 amid forecasts of an apartment glut. If only we had the redevelopment envisaged by the 2030 plan. The answer to rental shortages is to build, and rebuild. 2

January and February are notoriously the busiest months for renting, as university students clamber for housing before lectures kick off. But agents and tenants say the market for rentals has become increasingly tight over the past 12 months. Reports of tenants offering higher-than-advertised rent or even several months' rent in advance are already common.

Vacancy rates are at 25-year lows and pressure on rents is accelerating higher according to HIA chief economist Harley Dale. Dale also noted that the rental crisis was likely to worsen in 2007. 3

The Australian Bureau of Statistics say rents rose by 3.7 per cent last year, the fastest growth rate since 1991, but the Reserve Bank warned recently that there is much worse to come. That's simply because rents have not kept pace with house prices.

In the Reserve's latest statement on monetary policy, it said house prices had increased 175 per cent since the mid-1990s, while rents had risen just 35 per cent according to the ABS (or 60 percent by the real estate industry's count). Either way, the central bank is tipping "significantly larger rent increases" over the next few years. 4

Rental demand is easily outstripping supply. In Melbourne, the average rental vacancy rate in the inner city fell below 1 per cent in November - to 0.8 per cent. According to the Real Estate Institute of Victoria, the most recent figures for December showed the city's average vacancy rate was 1.7 per cent and 1.5 per cent in the inner suburbs. 5

Research firm BIS Shrapnel said it expects national building commencements to fall for a third straight year, dropping five per cent to 142,500 new homes in 2006/07 following a four per cent drop in 2005/06. 6

BIS Shrapnel senior project manager Jason Anderson said such a result would inflame the country's already tight rental market, which is meeting increased demand from a growing population. 7

"Rental markets throughout Australia are as tight as a drum, with vacancy rates in all capital cities below 2.5 per cent as at June 2006," he said. 8 "With the supply of new dwellings decreasing, rental markets are set to tighten even further in 2007 and 2008." 9

Mr Anderson said strong population growth supported by increased overseas migration would push demand for new homes, particularly for rental property use, up to about 165,000 in 2006/07, leaving a shortfall of about 22,500 homes. 10

The massive influx of migration to Melbourne has fueled the rental boom and has also seen that for the first time in memory, every suburban municipality grew in population, as increasing redevelopment saw a third of the city's population growth go into built-up areas. 11

Even councils such as Hobsons Bay, Moonee Valley, Banyule, Glen Eira and Monash, where populations have been falling for decades, grew in 2005-06 as urban redevelopment gradually caught on, despite resident opposition. 12

Rental Increases

The pace of development in central Melbourne slowed as the cranes came down from Southbank and Docklands, but the city council area still has the fifth fastest growth rate in the state. In five years its population has grown by almost a third, from 50,673 to 67,193. 13

At the same time as all these happenings, rents are increasing at twice the rate of inflation. According to the Rental Report from the State Government's Office of Housing, rents increased 6.4 per cent in the year to September 30. 14

"At one stage, we were seeing rent increases of $50, $60, $80 a week," according to David Imber of the Tenants Union of Victoria.

Mr Imber added that the union is also concerned about reports of renters being encouraged to "bid up" to get their tenancy application over the line. 15

Jellis Craig's head of property management, Loretta Truscott, says when the office re-opened on January 2, staff fielded about 300 calls a day. Conversations would get heated when people were told a property they had seen on the internet had already been let. "People are frustrated and a bit emotional, I think," she says.

Average rents on Jellis Craig's rent roll increased by 7 per cent in December and 6 per cent in November. While it's good for landlords, Ms Truscott acknowledges the pressure on tenants. "If the rental market keeps going like this, it is going to put more pressure on public housing. I think that is something the government should be concerned about." 16

To illustrate the point, Shun Wong a 24-year-old research consultant and his new flatmate earn about $100,000 a year between them, they still found the competition was intense for a two-bedroom Docklands apartment in the $400 to $450-a-week price range. Anything under $400 was usually one bedroom plus a study.

"Because you are all competing for the same property, everyone is trying to make a good impression," he says. Despite all the new Docklands apartments, Wong says he was surprised by the lack of available stock. Only five to 10 properties were available in NewQuay at the time the pair was looking. 17

Conclusion

Due to the factors already discussed, there has never been a better time to invest in the Melbourne residential market. The Annual Return Index measures the capital growth of an investment property together with net rental income, to give an accurate comparison between Australia's cities. Melbourne’s residential property has made a steady start in 2007 and will continue to do so in the long term. Investors should be very selective in terms of suburbs they consider for property investment. As always, look at the level of infrastructure and population growth of any new areas in Melbourne. Comparisons between the Capital cities are best considered over 7 to 10 year periods with all indicators pointing to Melbourne continuing to be a good option for property investment in the future.

Remember, that when you select a property as an investment, succumbing to the lure of tax savings is a fundamental mistake for investors. You do not attain financial independence through saving tax - you gain financial independence through the ongoing capital growth of your assets.

A cautionary note that must be adhered to is that there are many uncertainties in forecasting and many factors that can affect the timing of movements in the market. Amongst many examples, changes in government policies or interest rates can affect the timing and magnitude of cycles in property values. They can delay an upturn or precipitate a downturn. On the other hand, the sudden lowering of interest rates can fuel a boom that may not have been previously predicted. At the same time, such short-run factors are notoriously difficult to predict with precision.

Therefore, any forecasting vis-à-vis real estate as in this report should be taken to be an indication of market directions. Investment in residential property should have a time horizon of at least three to five years, so that investors are not forced to take premature and adverse action. To diminish the risk in residential investment, it is essential to ensure that the investment horizon is long enough to allow time for the elementary factors of the market to come through.

Consult with your accountant or financial planner as to what kind of investment best suits you and as long as you invest with a long term plan, you will reap the rewards!

1 Tim Colebatch The Age February 28, 2007

2 Tim Colebatch The Age February 27, 2007

3 Jehane Sharah MPA Issue 7.4 page 62 (2007)

4 Michelle Draper Sydney Morning Herald

5 Michelle Draper Sydney Morning Herald

6 AAP Sydney Morning Herald November 2, 2006

7 ibid

8 ibid

9 ibid

10 ibid

11 Tim Colebatch The Age February 28, 2007

12 Ibid

13 ibid

14 Michelle Draper Sydney Morning Herald

15 Michelle Draper Sydney Morning Herald

16 ibid

17 ibid