Melbourne’s property market trails inflation with 1.8% annual growth

Melbourne property has significantly underperformed over the past decade, with median house prices growing just 1.8% annually since 2017, falling behind inflation. This weakness stands in stark contrast to the extraordinary 20-year growth cycle that preceded it, which likely required a longer correction than other capital cities.

Decade of Disappointment

Data from the Real Estate Institute of Australia reveals that Melbourne’s median house price has only risen by 1.8% annually since early 2017, spanning 9.5 years. With inflation averaging around 3% during this period, Melbourne’s housing market has effectively become more affordable in real terms compared to nearly a decade ago.

It is not uncommon to meet investors who purchased a Melbourne property 10 years ago that is worth broadly the same amount today in nominal dollar terms. These investors have seen their purchasing power eroded by inflation, despite holding assets for a full decade.

Melbourne’s property market is significantly below its long-term trend, with houses and apartments priced around 21% and 29% lower than expected, respectively. In contrast, cities like Brisbane, Adelaide, and Perth remain above trend. Indicators such as high replacement costs and substantial price differences with other major cities suggest Melbourne’s properties might be undervalued.

Investors are questioning whether to retain assets that have shown minimal real capital growth. These concerns have prompted a detailed examination of the factors behind Melbourne’s underperformance relative to other markets.

Blame the Wrong Factors

When discussing Melbourne’s lackluster performance, commentators often highlight Victoria’s land tax policies and tenancy reforms. The state introduced a temporary land tax and lowered the tax-free threshold to $50,000, bringing many investors into the tax net for the first time.

While Victoria’s taxes are higher, land tax is just one of several expenses affecting property cash flow. Comparing holding costs between Melbourne and other cities, like Brisbane, can be complex due to varying local charges, such as Brisbane’s high council rates.

A recent case study involving a Brisbane-based investor revealed that purchasing an additional property in Brisbane, rather than Melbourne, would increase their land tax liability due to higher tax brackets. This example demonstrates that Victoria’s tax changes don’t always negatively impact investment decisions.

Victoria’s debt, approximately 25% of its gross state product, is another frequently mentioned factor. However, this level is not significantly higher than the federal government’s debt, which stands at about 20% of GDP. The connection between state debt and Melbourne’s property prices appears weak.

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Victoria’s economic fundamentals remain robust, with an unemployment rate slightly above the national average at 5.1% compared to 4.4%. The state also leads in population growth, both in absolute numbers and as the second-highest percentage growth rate, trailing only Western Australia.

The most important contributor to Melbourne’s decade-long period of underperformance is the strong growth that preceded it. Between March 1997 and December 2016, Melbourne house prices grew almost without interruption for almost 20 years. No other city has come close to a growth cycle of this length, with Brisbane’s 1980 to 1990 cycle running for 10.8 years, little more than half as long.

A market that grows for 20 years without a genuine reset accumulates a larger gap between price and the income, borrowing capacity, and construction cost fundamentals that ultimately support it. The length of the correction is proportionate to the length of the boom that preceded it. When investors lament a decade of virtually no capital growth, they should not be too quick to blame the state government. In many cases, the more important explanation is that they bought near the end of an unusually strong growth cycle.

Property prices may grow by a similar percentage each year, but because that growth compounds, the dollar increase becomes larger as the value of the property rises. This is why long-term price charts naturally curve upwards, often quite steeply, making the underlying trend difficult to identify. The analysis establishes a repeatable long-term growth benchmark informed by what each market has delivered over the past 45 years.

Looking Ahead

Investors should look forward rather than dwell on past performance. The key consideration is the return a property is likely to deliver over the next decade.

Melbourne could be approaching a stronger growth cycle. Improving yields, constrained supply, population growth and recovering sentiment could support future price appreciation.

Property investors who owned assets before Budget night will continue to benefit from negative gearing arrangements. Therefore, most will be reluctant to sell, because if they subsequently reinvest in an established property, they will lose immediate access to those tax benefits.

Methodology and Benchmarks

However, there is evidence that this rate is gradually declining. For this analysis, the long-term benchmark has fallen on a straight-line basis from 7% per annum in the early 1980s to approximately 6% per annum today.