WHERE TO NOW FOR MELBOURNE PROPERTY MARKET?

By Victor J Nicholas

December 5th 2008

When we thought we had seen it all in real estate circles, this latest calamity going by the seemingly innocuous moniker sub-prime has stricken the United States, the U.K., Germany, Iceland and elsewhere with the force of an economic tsunami that has sent many into a tail spin with the media gripped by daily horror stories of overseas lending institutions collapsing under the crushing weight of debt.

While seemingly striking over night, sub-prime is anything but an overnight sensation. Infact, sub-prime’s origins can be traced back to the US real estate boom in the late 1990’s where transient finance brokers eagerly lent money to borrowers who did not meet the usual criteria for borrowing at the lowest prevailing market interest rate.

While prices were on the up and up – the cracks were papered over temporarily by the new found equity that borrowers had in their heavily leveraged properties. However, when the United States housing bubble inevitably burst in late 2005, early 2006, - there was a sudden (though not unexpected) rise in default rates on "sub-prime" and adjustable rate mortgages (ARM). The higher risk lending practices were laid out bare and lending institutions were scrambling to recoup whatever money they could as borrowers capitulated under the changed conditions in a kind of domino effect that spiraled out of control to an extent that caught not only the lending institutions out – but also the US government.

The fall-out has been unprecedented, with a “credit crunch” which began in July 2007, when a loss of confidence by investors in the value of securitized mortgages in the United States resulted in a liquidity crisis that prompted a substantial injection of capital into financial markets by the United States Federal Reserve and the European Central Bank.

The panic in world credit markets reached historic intensity on 17th September 2008, prompting a flight to safety of the kind not seen since the Second World War. The record set after the Black Monday crash of 1987 was broken as the difference between the interest rates on interbank loans and short-term U.S. government debt exceeded 300 bps. Barometers of financial stress hit record peaks across the world. Yields on short-term US Treasuries hit their lowest level since the London Blitz in 1940, while gold had its biggest one-day gain ever in dollar terms. In the ensuing maelstrom lending between banks, in effect, stopped. 1

Concerted efforts by central banks to revive money markets with emergency cash auctions had not worked. The US Federal Reserve, European Central Bank and Bank of Japan joined with counterparts in Switzerland, the U.K. and Canada to pump hundreds of billions of dollars into the financial system. 2 All the while, world financial markets were staggering around in a punch drunk stupor that it was seemingly inevitable that little less than a month later on October 10, 2008, the difference between the interest rates on interbank loans and short-term U.S. government debt reached yet another new high of 465 basis points.

The shockwaves reverberated through financial institutions, retail and real estate markets world wide as the self fulfilling prophecy of an economic Armageddon unfolded before everybody’s eyes.

As we draw breath to consider the ramifications of the carnage that has engulfed world markets and shaken consumer confidence, there is little doubt that as of December 2008, we are almost certainly still in the eye of the storm of this defining moment in world economic history – but what immediate impact has it had on our real estate market in Melbourne?

To be sure we are seeing many gun shy buyers holding off from purchasing because of all the negative press that has gripped foreign and local media with seemingly more and more bad news filtering through each day. In an October 7, 2008 media release issued by Glenn Stevens, Governor of Monetary Policy for the Reserve Bank of Australia, Mr. Stevens stated that:

"Conditions in international financial markets took a significant turn for the worse in September. Large-scale financial failures in several major countries were accompanied by serious dislocation in interbank markets and heightened instability in other markets, including sharp falls in share prices. Official actions in a number of countries have been aimed at restoring stability, by adding to short-term liquidity and laying a foundation for longer-term recovery in the health of balance sheets. Nonetheless, financing is likely to be difficult around the world for some time ahead. This is also affecting Australia, albeit by less than in many other countries, given the relative strength of the local banking system." 3

Interest rates have been further reduced since then to the present cash rate level of 4.25% with signs that there may be further reductions early in 2009 by the RBA to counter-act against disinflationary forces. Mr. Stevens on the December 2 2008 meeting of the RBA stated that:

"The Australian economy has been more resilient than other advanced economies, but recent data nonetheless indicate that a significant moderation in demand and activity has been occurring. With confidence affected by the financial turbulence and a decline in the terms of trade now under way, more cautious behaviour by both households and businesses is likely to see private demand remain subdued in the near term. With that outlook, and with capacity pressures now easing, it is likely that inflation in Australia will soon start to fall. " 4

What we are now seeing in the present time is that declining interest rates in Australia have created the perfect opportunity to buy property. For overseas buyers, the added advantage is the presently weakened state of the Australian dollar against other global currencies. For overseas investors in particular your money buys more in Australia at this point of time. This also holds true for local investors who are seeing borrowing costs greatly reduced.

There continues to be a huge number of overseas students who require accommodation as Melbourne is currently home to over 11,000 international students, most coming from South and North East Asia. Finding adequate accommodation for everyone is very difficult and the pressing demand for apartments close to tertiary campuses in the Melbourne CBD continues to be high. 5

Victoria’s population growth has been extraordinary in the last year, adding to the strains of its housing shortage. Its population grew by 92,734 or 1.78 per cent over the year to June, up sharply from 78,286 a year earlier. The bureau has yet to estimate where the growth is happening, but a year earlier, 80 per cent of the increase was in Melbourne, and there is no reason to think that has changed. 6

The figures come as the Housing Industry Association warned that Victoria is likely to build 7000 fewer homes in 2008-09 than it needs to keep up with population growth, let alone reduce the backlog. 7

All this points to a boon for investors as demand for quality apartments in Docklands, Southbank, Melbourne CBD as well as other well located property will naturally be greatly in demand for the large 20 to 30 age group which forms a significant proportion of the population according to recent data.

In summary, despite all the doom and gloom that has reverberated through the media, the next generation of millionaires will be forged over the next year by the pro-active decisions they make now. With interest rates on the descent and property prices holding steady, the opportunity for investors to get involved in the property game due to borrowing costs being at a reassuringly manageable level surely spells good news for the astute investor as well as the first-time budding property tycoon.

The undersupply of new housing has created a 'natural floor' under property prices which is helping to maintain the value of real estate at the present point in time. This represents a natural safeguard that other forms of investment cannot always emulate.

For reliable financial and property information of any sort, you must consult an officially qualified professional to assist you as each individual’s requirements and capacities are different.

1. Krishna Guha in Washington, Michael Mackenzie in New York and Gillian Tett in London Published: Financial Times September 18 2008 2. Gavin Finch and Kim-Mai Cutler Bloomberg.com September 24, 2008 3. RBA media release, 7 October 2008 4. RBA media release, 2 December 2008 5. Kate McPherson - Overseas students compete for Melbourne rentals - Radio Australia, 8 September 2008 6. Tim Colebatch, Canberra December 3, 2008 7. ibid