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What are the prospects for off the plan apartment investments?

Off-the-plan (OTP) residential property developments have redrawn the skylines of our cities and many parts of inner and middle suburbia in the last decade. The spread of high rise living out of a few well-defined CBD and CBD-adjacent pockets and into suburban strips has been remarkable.

The business model of OTP – pre-sell the concept to a critical mass of buyers to secure the lending to finance construction – has been refined and perfected over that time. Prospective owners are wooed by no-expense-spared websites and coffee-table standard brochures. The proponents are not selling slabs and cement, but a set of wishes that even Aladdin might baulk at granting: swimming pools, gyms, in-house cinemas, designer rooms, European appliances, car parking, high security and fabulous views. Inevitably, the genies of developments woo the willing into their caves – elaborate display suites featuring replicate apartments and 2-metre tall models of their 25-storey towers – to secure deposits and signatures on the dotted line.

ABS building activity data starkly demonstrates the outcomes. For most of the noughties, unit commencements nationwide sat between ten and fifteen thousand units a quarter. Commencements rose steeply around the start of this decade to reach over 30,000 a quarter in March 2016 and have since settled around the 25,000 mark since. In short, unit commencement doubled in a decade.

An ABS analysis published in February starkly illustrates the potential impact of the most recent apartment building approvals, should they all proceed. The ABS drilled down to an almost suburb level to consider the number of approvals granted since the last census. Unsurprisingly, it confirms the expansion of apartment building beyond the traditional CBD and CBD-adjacent suburbs. But what is shocking is the amount of new development within the traditional areas. For instance, take Melbourne CBD and Southbank. The ABS has calculated that apartment dwelling stock could grow 23 and 27 per cent respectively from that recorded in the 2016 census. Adelaide and Sydney CBDs could add 21 and 17 per cent more stock respectively.

This would be glut-like conditions even in the best of times where one would expect prices to fall in response to oversupply. Yet, it is far from best of times for high rise.  The ‘dream’ sold by marketeers has been tarnished by a run of bad publicity: sneaky sunset clause contract cancellations, cladding fires, the structural problems at the Opal Tower and tales of overcrowding in some towers.

Further, the model for selling apartments is also vulnerable in light of the banking royal commission.  Many investors bought apartments after a recommendation from a financial adviser. But these advisers were receiving large commissions – sometimes as large as 10 per cent – from developers to recommend the property.  In recent times, financial advisers have ‘managed’ this conflict by declaring more clearly the commission in their client paperwork. But former justice Hayne has made it clear that just managing conflicts in the financial sector isn’t good enough anymore. The other blow from the report relates to securing finance. The customer-pays model that Hayne has recommended will mean mortgage brokers will be far more selective about the work they accept given how price-conscious clients will become. Brokers will focus on predictable propositions that are more likely to succeed and demand the least resources to secure finance. OTP apartments do not represent that.

There is one silver lining for the OTP sector: the planned preferential treatment of negative gearing by a federal Labor government, should they win the next election.  The developers will naturally market this plus for dear life. But a modest tax break on rental losses really isn’t much of a selling point if the asset’s likelihood of capital growth is minimal given the glut of supply.