For the first time in many years leading apartment developers have become very nervous about a pending fall in the values of Sydney and Melbourne apartments plus parts of the suburban residential housing market in both cities.
Already, prices of inner city Sydney apartments have started to fall -- something we have not seen for many years.
The new forces that are emerging are far more important than anything the Reserve Bank decides on interest rates because they could hit the biggest driver of the economy in the post mining boom era -- apartment building. And if dwelling prices fall, then it will almost certainly reduce bank profits.
The current danger has been triggered by inexperienced politicians in both Canberra and Victoria simultaneously deciding that there is community support for attacking Chinese and Asian buyers even though they are the dominant buyers of major parts of the residential markets in Sydney and Melbourne.
The Victorian and Federal moves raise only small amounts of money so are simply about garnering political support.
To understand why the new Chinese taxes and penalties are so dangerous, you need to grasp what is now happening in the Sydney and Melbourne property markets.
In Sydney, over 80 per cent of inner city apartment buyers are Chinese or Asian investors. In Melbourne’s CBD the figure is even higher.
The Chinese buyers are not big institutions but rather they are mums and dads that have made some money in their home country and see Australia as a good place to invest. Often they have been driven by a herd mentality in communities where families inspire each other to buy Sydney or Melbourne apartments -- it’s similar to what happens at suburban barbecues in Australia.
In any market, when a herd gets frightened it can turn viciously in the other direction. And that's the real danger we face.
The situations in the two capitals are different but they are also linked. Let’s start with Sydney.
In recent months, Sydney apartment rents have been edging up partly because more people are living in each apartment but, in contrast, the actual prices of inner Sydney apartments has started to fall. Yes fall. No one has heard about falling apartment values in Sydney for a long time.
The good news about Chinese investment in Sydney is that the biggest developer, Meriton, insisted that the Chinese families who bought apartments rent the apartments so there is no big vacancy overhang.
In Melbourne it has been a different market. The biggest developers are Chinese institutions often supported by Chinese banks. Some 20,000 apartments have been approved in the CBD, almost all are Chinese/ Asian backed developments and the number of apartments in the inner suburbs is of a similar magnitude, also with a high level of Chinese buying.
These are massive figures and the current and planned construction is underpinning the Victorian economy.
In most developments, Chinese and Asian investors pay a deposit (10 per cent is normal but it may be lower in Chinese bank funded projects) and on that basis the apartments are built -- it’s a straight ‘off the plan’ property development system. But, unlike Sydney, many of the apartments that have been completed have not been leased. So there is a vacancy overhang which makes the market more vulnerable than Sydney.
Chinese residents in places like Hong Kong, Beijing, Shanghai and Guangzhou who buy new developments off the plan are legally entitled to make such an investment.
But if they make an investment in an existing dwelling they are breaking Australian law. But it is a law that has never been enforced and given we are dealing with many thousands of small Chinese families it is likely that large numbers will not know about what must seem a strange law.
Nevertheless, a substantial number of ‘mum and dad’ residents of China were told that it was better to link up with relatives, friends or an ‘introduced’ local in Australia to buy the properties.
In nominal terms, the registered owner of a large number of suburban houses and apartments then becomes a local Chinese business person, often running a business such as a restaurant but in fact they are fronts for overseas Chinese residents.
This has been a lucrative trade for local Australian families of Asian origin and many have over-indulged. If only one or two properties are bought based on an existing business, it might make sense and the front would withstand investigation. But when people have bought a large numbers of apartments, it will become difficult to conceal the fact that the local Australian Chinese are fronts for Chinese buyers.
So, in chasing votes, Tony Abbott & Co have blundered into very dangerous waters by imposing new penalties. But there is a period of grace and so we are likely to see a number of Chinese families sell out rather than risk penalties should their ‘front’ activities be revealed.
On its own the danger from Federal action might be contained because it is enforcing an existing law but simultaneously the Victorian government has put a stamp duty levy on apartment developments sold after July 1 and then a half per cent levy on the annual returns achieved. Given that returns are low, this continuing charge is a massive impost. On its own, perhaps Victoria’s action might be managed but developers say the combination could be lethal.
To comprehend the full danger we have to understand how we attracted this vast volume of ‘mum and dad’ Chinese investment in Australian dwellings in the first place.
They simply fell in love with their image of the country -- its fresh air, its health services, education and so on. One day they, or their children, might live here. We rolled out the red carpet and slick sales people all around the region sold Sydney and Melbourne apartments and residential properties in the same way as encyclopedias, electricity and various kinds of investment scams have been marketed here in Australia.
Suddenly, two governments are sending messages that many Chinese may interpret as meaning they are no longer welcome. If a few Chinese feel unwelcome and start selling properties, the message will get out that there are big losses.
In Melbourne, there is already a big difference between ‘off the plan prices’ and the sale value of completed units. In Sydney, if Chinese buying turned into selling, the market would collapse and that collapse would affect values of a wide range of Sydney residential properties.
As we have seen so often in other markets, there is always a danger that the herd mentality that drove the buying will also drive the selling.
Victoria desperately needs those apartment developments to get it through a difficult economic period. If the apartment market cracks, it will spread to the inner suburbs and Chinese investment there.
Australian banks have over leveraged their loans on residential property.
David Murray’s warnings that extra capital is required are now terribly important given the dangerous game the Federal and Victorian governments are playing.
I hope my warnings prove to be false and anyone writing about what Chinese investors are going to do is in high-risk territory. That said, people I trust in the real estate sector are looking more nervous than I have seen them for a long time.