Experts in housing economics have demonstrated how a new supply of dwellings tends to have a far less significant impact on dwelling prices in large cities than commentators expect. At a time when other commentators were predicting a crash in the London markets, Michael Oxley concluded:
"With only 6 percent of all houses in London being newly built, the idea that house prices in London would fall in the event if there being an increase [in the building of new houses], even a massive increase, is highly implausible".
On the other hand, by way of an example, take a look at the south coast of New South Wales where there might only be 10,000 households in a regional town - a new supply of turnkey package housing packages can materially alter the balance of supply against demand, and this can also cap dwelling price growth in the established stock.
A glance at the number of owner occupier loans written by purpose in Australia on a rolling annual basis shows two things. Firstly, only a relatively small percentage of the housing stock ever transacts in any given year. And secondly, most of the activity relates to the buying and selling of the established housing stock, rather than new dwellings (click charts to expand).
What about investors? Well, the chart below is the one which is getting everyone hot under the collar right now, because the level of investor activity is rising strongly just as it did during the last major property boom in around a decade ago. And, in fact, thanks to tempting low interest rates investor demand rising more strongly than the demand for owner occupied loans at this point in time.
It is clear that in some areas are more investors in the market than is healthy and this will lead to some pretty unbalanced markets on a micro level. However, despite popular belief on a macro level Sydney is not heading for a massive oversupply of property. Let's take a look at precisely why in three short parts.
Part 1 - Vacancy rates
One handy (although not foolproof) indicator to look at is rental vacancy rates, which shows that vacancy rates are much lower than they have been historically. This is particularly the case in Sydney where rental vacancies were well above four percent during the last property boom which "ended" in early 2004.
If we take a look at New South Wales vacancy rates on a regional level you will find that the real risk of oversupply is is regional areas, not in metro Sydney itself. In the inner suburbs (0-10km ring) vacancy rates in Sydney have long been well under 2 percent, and in some inner western suburbs vacancy rates have tracked at around only 1 percent for a decade now. More supply is to be welcomed.
Part 2 - Approvals by capital city
What about approvals in the pipeline? If you look at the chart below for the whole of Australia some key points immediately become clear.
Building approvals are in total are tracking at close to their highest ever level on a rolling 12 monthly basis at just over 195,000. If all of these properties are eventually built they will add a little over 2 percent to the total established housing stock of 9,300,700 dwellings.
The type of property which is more likely to see oversupply in this cycle is clearly the attached dwelling - units and apartments - with approvals breaking record highs.
Melbourne has approved many thousands of houses over the last half decade, but Sydney most definitely has not. There is little oversupply risk here for the harbour city in aggregate, although there may well be in some fringe estates where demand for housing can initially be very low.
On a rolling annual basis Sydney has approved only 12,463 houses as you can see above, but many more units at 28,602 as recorded in the chart below.
Will this lead to a massive oversupply? On a city wide basis - no - for two reasons. Firstly, because population growth has exploded higher in New South Wales with the state adding 114,500 persons in the year to March 2014 as I analysed here.
We don't yet know what precisely what proportion of that population growth took place in Greater Sydney, but the answer is probably somewhere close to 90,000 (in FY13 the comparative figures were 80,300 for Greater Sydney and 105,400 for New South Wales, the city metropolitan area accounting for 78 percent of the growth).
And secondly, because in all likelihood apartment approvals in Sydney are already a couple of months past their peak as has been indicated by the plans of major developers, although we will need to see another month of two of data to confirm the downtrend (approvals could certainly have a second wind if prices continue to rise strongly, and the strongest part of the year for apartment approvals is coming right up).
Past 3 - Commencements
Approvals are one thing, but what are we actually building? At the state level in New South Wales we saw 20,225 house and 25,129 unit commencements in the year to March 2014.
Yes there are still a healthy level of approvals in the pipeline, but the vital point to note that here is that even if these commencements are perfectly allocated against demand (and there is zero chance of that) this number of commencements is barely enough new stock to keep pace with population growth, let alone address the issues of stock obsolescence and half a decade of chronic oversupply.
It is possible that the number of persons per dwelling could shift around a bit and the forecast decline to below 2.5 persons per dwelling may not play out, but even if every single one of the ~41,000 approved dwellings over the past year are built, this hardly represents a significant oversupply risk given the unbridled pace of population growth.
In short, the risk of an imminent city-wide oversupply in Sydney has been widely, and in some cases wildly, overstated. Of course, as in any construction cycle there will be pockets of oversupply, and in this cycle there will be a glut of apartments in certain suburbs.
The sectors where a temporary oversupply will likely eventuate include the Central Business District itself where new Chinese-funded tower blocks will appear on the skyline, in certain parts of the inner south and around the airport (there are thousands of new apartments sprouting up in some of these suburbs - far too many), and within a number of the Urban Activation Precincts (UAPs).
We would not recommend buying a new apartment in potentially oversupplied locations, that much is certain. In particular, there is likely to be risk in buying apartments off the plan for a number of reasons.
It is hard to know exactly what you are buying when you go off-plan, there will be dozens of properties almost exactly like yours which applies downwards pressure to that market as and when you want to sell, there is a greater risk of oversupply of units than there is of an oversupply of houses, and new apartments are often painfully expensive when compared to established stock.
Yes, some investors will buy new apartments and then see the values fall as the perceived value of those shiny new units depreciate.
But as for a risk of a huge oversupply of property in Sydney? That appears very doubtful over the near term. Investors would likely be better served to stick to quality established stock in supply-constrained suburbs with good transport access to the city.
If there is one thing I learned from working in the mining industry, it is that forecasting commodity prices is a fool's errand.
Working in the copper/gold/silver sector each year I prepared budgets and forecasts based upon a range of assumptions, but realistically who could have forecast the outrageous swings in fortunes of those commodities through the past decade? Certainly nobody preparing the wildly inaccurate stockbroker reports, that's for sure!
Let us take a 60 second run through what's happening to the bulk commodities right now which is causing a great deal of excitement in the media and a great deal of pain to Western Australia's budgets in particular.
Since it accounts for almost one third of the Reserve Bank's commodity price index, iron ore is attracting most of the headlines, but as we will consider below, it could be the coal mining regions which face the brunt of the pain.
Part 1 - Price
As I looked at here the respective prices of coking coal and thermal coal have genuinely crashed, and with Australian coal mines at the sharp end of the cost curve we are going to see an ugly shakeout of the high-cost producers and elevated levels of unemployment in coal mining regions.
That turn leads me to be fearful for property markets in coal mining towns and regions of Australia.
As for the iron ore price, well, history shows that commodity prices frequently overshoot on the upside in a speculative frenzy and on the downside as producers flood the market with a glut of supply, and we are currently in the latter phase during this cycle.
How far this has to run is anybody's guess - it's nigh on impossible enough to forecast in markets where the LME provides great transparency on warehouse stocks let alone where assumptions are reliant on rubbery data out of China.
We're still in the midst of a spectacular downtrend at present which will hurt Australian income, is pushing the Australian dollar dramatically lower and is now likely to force marginal producers to the wall and out of the game, until upwards pressure returns on prices, however long that may take (click chart).
Part 2 - Supply
The Reserve Bank has implied hopefully that declining commodity prices could elicit a slowing of supply from the large producers.
That faint hope seems highly unlikely looking at the latest data out of Port Hedland, which shows that at the current pace of growth iron ore tonnages exported from the Pilbara could soon be double what they were only in October 2012.
That's a heck of a lot of iron ore cargo bound for China's burgeoning stockpiles!
The RBA's own charts show an incredible boom in iron ore supply from Australian shores - so huge, in fact, that the increase in trade volume has completely offset the collapse in prices...to date at least.
There is little point in warning that property prices and rents could crash in the Pilbara, since completely unsurprisingly, they already have.
Part 3 - Demand
What about demand from China?
Strangely certain PMI readings have have continued to suggest ongoing expansion. These indices are notoriously difficult to read - folk tend to get excited when they fall below 50, but in an economy such as China which has been growing at 7.5 percent, a reading with a '49 handle' might only suggest 'less fast' growth, which in fact is eventually is inevitable.
In short, it is impossible for the Chinese economy to continue growing at 7.5 percent in perpetuity - if it did then due to the compounding effect the economy of China would relatively quickly dwarf that of every other country in the world.
Something doesn't really seem to stack up here. More likely than not, a significant amount of the Chinese data is materially overstated as has been suggested by mismatches in import/export figures and as I looked at briefly here.
Part 4 - Production
The Reserve Bank acknowledges that its own data out of China related to mining production costs is at best opaque, but also makes the point that iron ore spot prices in the $70-80 range should shake out foreign producers first, with most of the big-hitting Australian miners much further down the cost curve.
Whether or not this proves to be wishful thinking we will find out in due course, but some Australian producers are looking increasingly marginally profitable. If the RBA's research is accurate supply from China should slow since many of its producers will now be loss-making.
Australia's coal mining producers are now resembling rabbits caught in the headlights with our relatively high production costs making much of our coal production unprofitable, both for thermal coal and coking coal.
I looked at the possible impacts here, but in short, while marginal coal producers may keep the show on the road for a little while, further mine closures and redundancies look to be all but inevitable in the current climate.
The two charts below show just how many Australian coal producers potentially face making losses unless they can somehow slash costs or commodity prices rebound quickly.
A nasty shake-out looks unavoidable for some mining regions and producers.
I took a wander down The Bishops Avenue in London's N2 yesterday and was interested to see that the heating of the housing market over the past year is resulting in development activity with every second property emitting the gentle tapping sound of chisels at work.
The strip is informally known as "Billionaires Row" in London, with properties on the market such as the currently unoccupied Heath Hall commanding interest at around the £65 million level.
The leafy road, which is located close to Hampstead Heath and East Finchley, has attracted controversy over the years since in the most expensive strip of houses a swathe of 16 mansions stood totally empty for decades.
Since the derelict properties are generally owned by Saudis, uber-wealthy Indians and Pakistanis, oil sheikhs or families from Brunei who rarely (if ever) visit them, The Bishops Avenue vacancies have led to calls for punitive council taxes to be levied upon unoccupied mansions.
In the most expensive strip of properties about a third of the houses remain empty - I snapped just four of them below...well, it's not as though there is ever anyone home to complain!
For all the above, the recent rise in dwelling prices has caused a number of sites to come under development and has brought several others to market.