Tim Lawless is research director, Asia Pacific, at CoreLogic and heads its RP Data research and analytics team which analyses real estate markets, demographics and economic trends across Australia. He was a guest speaker at the 2nd annual UNSW Real Estate Symposium, hosted by the Real Estate Initiative of the Centre for Applied Economic Research at UNSW Business School. Lawless spoke to Julian Lorkin for BusinessThink.

An edited transcript of the interview follows.

BusinessThink: We've seen a 90% rise in house prices during the past decade in Sydney and Melbourne. What do the real underlying numbers show and what's the real reason?

Lawless: We've seen two cycles in growth since the beginning of 2009. Of course, post-GFC we saw values falling during 2008 so it is quite a surprising rebound in the housing market. Sydney values are up by a little bit more than 90% over that past seven years; Melbourne values are up by close to 70% during the same time frame. So we have seen very strong growth.

What's causing it? Well, there's a whole bunch of factors. One of them of course is just the very strong economic situation in Sydney and Melbourne. That's where most of the jobs have been created during the past 5 to 10 years. It's also where we've seen very strong population growth. Remember, the mining states have gone through a downturn both economically and in migration; a lot fewer overseas migrants, a lot fewer interstate migrants coming through. That's not the case in Sydney and Melbourne – in fact, both cities are seeing nearly record levels of migration rates, which is adding to housing demand.

[Take] those strong economic conditions and the migration rates and add interest rates to it and we've got a recipe for a very strong housing demand, particularly for investors. We're seeing more than one-half of the NSW marketplace for mortgage demand is investment-related at the moment.

BusinessThink: And those investors seem to be particularly going for units, as opposed to houses. But we've got a huge amount of supply of units coming on to the market, certainly during the next 12-18 months. Is that going to impact on the investors?

Lawless: That's right. Investors are very skewed towards the apartment sector. Part of that is simply the fact that there are a lot of apartments available, for now, and buying off-the-plan is very appealing for some investors. We also see apartments offering a more attractive yield profile. So detached housing is showing, in Sydney at least, a gross yield profile that's below 3%. It's about 2.8%; it's never been that low. At least apartments are still around the 4%, [though] a little bit less than that in Sydney.

So we are seeing a lot of investors in that apartment space but, as you say, we are now seeing record levels of new apartment supply coming into the marketplace, which is likely to add some dampening pressure to the rate of capital gains. So for investors, if you're buying into a marketplace that's already relatively low yielding and your prospects for capital gains start to become neutered, there's probably going to become some level of disincentive for buying into this marketplace going forward if we see that same dynamic. 

'We're seeing more than one-half of the NSW marketplace for mortgage demand is investment-related at the moment'

TIM LAWLESS

BusinessThink: When you say disincentive, it almost sounds as if the investors are going to start wondering if there's any real benefit in investing when they get, say, a 3% or 4% yield on it, where capital gains may not be so good in the future. So is there a danger that they might all pull out – in which case suddenly you end up with a glut of supply and not that much demand?

Lawless: If we look at investment now in Sydney being more than half the level of mortgage demand, [and] if we were to pull that demand out of the marketplace, that's going to leave a pretty substantial hole in the level of housing demand across Sydney. So there is some risk there that if we do see investors leaving for other asset classes we may see some demand shortage in the Sydney housing market.

Look at the other asset classes, though. Are they really that attractive to investors at the moment? Well, cash and bonds, they're not really returning very much at all. Equities are still relatively volatile and there's still some fallout from 2008 when a lot of people saw their share portfolios virtually halve. So I think that's one of the reasons why we are still seeing investment [being] very popular in Sydney housing, despite the relatively low rental returns and maybe some neutered prospects for capital gains going forward.

BusinessThink: I also see those transaction numbers declining quite markedly in some areas. Of course, Sydney and Melbourne are way ahead of other areas such as Perth or Brisbane.

Lawless: That's right. We have seen transaction numbers tapering across Sydney, but also across most of the other capital cities as well, for a number of reasons. One of them is simply the fact that there are not many listings out there in the Sydney marketplace. And one of the reasons that we are seeing some upward pressure on prices is that there's not a lot of stock to choose from, or established stock, stock that's currently advertised for sale.

But another reason why we are seeing transaction numbers falling away comes back to the lending scenario. Banks are becoming more risk-adverse – generally buyers need larger deposits to enter the housing market now. Generally they now need a 20% deposit. Then you've also got just natural affordability constraints. Sydney houses are about 10 times the value of a typical household income. It simply means that more and more prospective buyers are being blocked from the marketplace due to the fact that they can't afford to enter.

'The lower cost of debt is one of the things that's fuelling housing demand. We haven't seen interest rates, or mortgage rates at least, this low since 1960'

TIM LAWLESS

BusinessThink: And how about the impact of interest rates? We've seen interest rates quite steadily declining during the past few years. What will happen?

Lawless: Well, interest rates have been dropped 11 times since 2011, [and] on each occasion [by] 25 or 50 basis points. Of course, the lower cost of debt is one of the things that's fuelling housing demand. We haven't seen interest rates, or mortgage rates at least, this low since 1960. So we are seeing a very low cost of debt that is driving some level of activity in the housing market.

BusinessThink: Can I briefly ask about rents as well? They don't seem to be increasing at all, and in fact in some cities they're going down.

Lawless: That's right. In Sydney, the biggest rental market, we've seen rents actually flat during the past 12 months. Melbourne's one of the strongest rental markets and rents are only rising at about 2% per annum. In Darwin they're down by about 20%; in Perth rents are down by about 10% during the past 12 months. So compared to the rate of capital gains, we are seeing relatively weak rental conditions, which of course is compressing the rental yield profile for investors. So we have seen rental yields hit new record lows during the past few months and they are likely to push further lower as we see rents hardly moving across most capital cities.

BusinessThink: Finally, can I ask you to do a bit of crystal ball gazing? Not just in the short term but let's look out to maybe five or 10 years' time. Can we say what might happen to the Sydney and Melbourne real estate markets?

Lawless: Well, in some ways, looking at the past cycles gives us a few hints on what to expect going forward. Of course, the economic conditions at the moment are very different. Think back to 2001-2004 when Sydney went through a similar magnitude of value growth during the same sort of time frames. The next five years on we saw ... well, the first three years of that five-year period we saw values falling in Sydney by about 10% and then we saw relative stability in the marketplace. So potentially, that's maybe an outcome for the Sydney marketplace now.

We are still seeing relatively strong economic conditions. We're still seeing, at least in detached housing, an undersupply but we are seeing more and more buyers now looking towards the more dense markets – apartments, townhouses and so forth – generally because they offer more affordable price points, but they're also generally located in more strategic positions.

So will we see a crash in the Sydney marketplace? Well, probably not, but my guess is we will see an ongoing tapering in the rate of capital gains we've seen during the past four years and potentially some level of correction in the marketplace before we do see things stabilise and hopefully see some rebalancing in affordability and in rental ratios as well.