Top 10 contrarian opportunities as Melbourne house-to-unit price ratio hits record high

Unprecedented dynamics

Rental vacancies are set to fall to tight levels across Australia as the international borders reopen, according to Pete Wargent, co-founder of Australia’s first national network for buyer’s agents, Pete Wargent.

Mr Wargent said, “we are in a very unusual situation, with a backlog of arrivals waiting to enter Australia after two years of border closures, and in turn, there is an opportunity for investors seeking both capital growth and rental returns, leading to strong total returns for landlords.”

“There have been a number of factors driving the looming rental shortage. We no longer have high volumes of investors from mainland China to drive the construction of new high-rise units, which has dampened the supply of new apartments” Mr Wargent said.

“Up until 2012, house and unit prices in Melbourne were tracking each other closely, but then a surge in high-rise construction has led to a divergence over the past decade. In fact, while the house price index for Greater Melbourne has increased by 223 per cent over the past 18 years, the unit price index for the city has only increased by 114 per cent over the same period”.

Figure 1 – Melbourne house and unit prices 2003- (indexed)

“While not all units are created equal, we believe there are some opportunities for contrarian investors in Melbourne to buy investment grade units in suburbs where is a high land value content in the asset. Investors should look for a point of scarcity such as exceptional views, or alternatively look at spacious 3-bedroom units, or perhaps focus on another point of scarcity” Mr Wargent said.

Population growth returns

Mr Wargent of BuyersBuyers said that more than any other city in Australia, Melbourne has been impacted by the absence of international students.

“We have a very strong population pyramid in Australia which is driving a surge in household formation. A substantial number of young renters have entered the rental market, as the lockdowns encouraged more renters to find their own space at the earliest available opportunity” Mr Wargent said.

“The absence of international students has had an outsized impact on Melbourne’s rental market; however the situation will begin to normalise in 2022”.

Figure 2 – Australia population pyramid

“Now the borders have reopened further from February 21 and given that we have a backlog of two years’ worth of arrivals wanting to come to Australia, we can expect the snap-back in rental demand to be strong”.

“Indeed, SQM Research reported a sharp drop to a 16-year low in the rental vacancy rate, driven by sudden sharp declines in Sydney and Melbourne in January. People are returning to work now, and this tightening trend has continued in February for both Sydney and Melbourne.”

“We can expect to see national rental price growth rising into the 10 to 20 per cent range forthwith, with most rental markets around the country already experiencing tight conditions” Mr Wargent said.

“Melbourne is going to take longer to see tight rental markets, with significant interstate migration to Queensland seeing the state of Victoria’s population actually decline through the pandemic, which was a very unusual dynamic”.

Figure 3 – Rental vacancy rates in January 2022 

Opportunities for contrarian investors in Melbourne

Doron Peleg, CEO of BuyersBuyers said that increased demand for lifestyle and flexible or remote working has been a factor in the tightening rental markets.

Mr Peleg said, “some households have required office space to work from home, while wealthier households have taken the opportunity to buy second homes, which has depleted the available rental stock. Others are simply taking the opportunity to live in Australia’s popular coastal markets, which offer an exceptional combination of lifestyle, climate, and relative affordability.”

“We are now seeing some opportunities in some markets for investors in apartments to experience capital growth and increasing rents, leading to strong total returns. The house-to-unit price ratio is Melbourne is at all-time highs, reflecting that affordability for houses is becoming a challenge for many buyers”.

“The rental supply in some areas of Melbourne is unlikely to respond quickly enough to the surge in demand for rentals, particularly in an election year when there is inevitably going to be level of uncertainty created by a potential change in government” Mr Peleg said.

Pete Wargent of BuyersBuyers said that some of the trends created by the unprecedented border closures and pandemic restrictions will be transitory, and therefore investors should look through short-term noise to focus on long-term fundamentals.

“Our analysis shows that there are some opportunities for contrarian investors in Melbourne apartments, with budgets of between $650,000 and $900,000”.

Figure 4 – Top 10 suburbs for apartment investors in Victoria

Mr Wargent said, “investors seeking long-term capital growth and strengthening rental returns should focus on certain opportunities as rents get set to rise.”

“In the unit market, there are opportunities for contrarian investors in Melbourne. Vacancy rates in many of these suburbs are still above pre-COVID levels for now, and it may take some time for rental markets to tighten again. But the latest mobility data suggests that activity is picking up strongly in the city of Melbourne now, which is heartening to see” Mr Wargent said.

“Asset selection is especially important in these markets – investors should ideally look for more spacious, established properties, which may be more family-friendly.”

“Generally speaking, we look for well-established, boutique unit developments with reasonable strata levies, and if the budget permits, look for family-friendly units with owner-occupier appeal, in those popular suburbs where the supply is somewhat capped” Mr Wargent said.

“Reserve Bank of Australia research has previously shown that new migrants and arrivals to Australia tend to have only a limited impact on the housing turnover rate, because most new arrivals are renters initially, especially international students.”

“That means a lot more demand for rentals is coming in 2022. As the border reopens, many parts of Australia may experience chronically tight rental markets” Mr Wargent said.

“Melbourne may prove to have ample rental supply in the immediate term, but things will surely tighten later in 2022”.