The fundamentals of the residential property sector in Melbourne — the epicentre of Australia’s recent property bubble —  would be concerning to even the most bullish of property investors. After almost a decade of solid growth, in which  Melbourne’s median house price almost reached $500,000 (and came close to overtaking Sydney’s median) the bulls appear to have been quickly silenced.

Not only did RP Data report a 4.3% fall in property prices over the past 12 months (in real terms, the drop was closer to 7%), but a report by SQM Research indicated that Melbourne’s rental vacancy rate has rocketed to 2.8% — almost double the national average. Following a construction binge, SQM claims that more than 10,000 rental properties are vacant. Given the net rental yield on investment properties is already an anemic 2-3%, the new supply coming online will almost certainly cause a further depression in rental yields, which would be catastrophic for housing investors.

The doesn’t look like improving in the short term. This is because the recent boom has led to a building binge, with more than 30,000 dwellings under construction in Melbourne, many of those dwellings are centred around the CBD and Southbank. With an existing overhang, it would appear fanciful to suggest that the market could absorb a large proportion of that new stock (especially given the high Australian dollar and recent drop in overseas students) without an even greater drop in rental yields as landlords slash asking rentals to achieve some sort of return on their investment.

But the situation is likely far more dire than even SQM suggests. A study undertaken by Earthsharing Australia in 2009 found that based on water usage, the real vacancy rate in Melbourne is about 7%, meaning that there are about 30,000 vacant properties (before the new stock comes online). This casts substantial doubt over the myth that Melbourne, which has experienced the most significant capital growth of any Australian capital city in recent years, is facing a housing shortage.

The glut of rental properties appears matched by Melbourne’s tepid rental growth rate with RP Data finding that the Melbourne’s average rental amount rose by 2.3% in the past year, below the rate of inflation. As this column has suggested, if there really were a housing shortage, it would be reflected in higher rental costs, rather than higher property prices.

With the imputed “price earnings” ratio for investment property somewhere between 30 and 50 times annual imputed “earnings”, this further shows why property is terribly expensive (in an investment sense). With income (that is, net rental earnings) falling in real terms, and likely higher rental vacancy rates, there appears no justification for prices to be based on a substantial earnings growth “multiple”.

If property investors were rational types, and required an adequate risk adjusted return (which in this climate, would require a yield of at least 5-6%), the prices would need to halve. But don’t mention this to property bulls.

Meanwhile, high-profile Melbourne real estate agent John Keating, whose honesty appears to indicate that he’s in the wrong profession, continues to challenge the Real Estate Institute of Victoria and the alleged “under quoting” that remains rife in the industry.

The Saturday Age reported that Keating, the founder of the REIV Ethics Committee, is continuing to push for vendors to publish their “reserve price” before the auction. That idea was actually suggested by this column three years ago, and would bring a far greater degree of transparency to the auction process.

Unsurprisingly, the real estate lobby is not in favour of such proposals.

Peter Fray

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