Interstate property investors: Beware the Melbourne trap!

First, the good news.

It’s encouraging to see analysts tipping Melbourne as the number one investment destination for 2025.

For investors though, it’s worth investigating beyond the headlines to understand the reasons why Melbourne is being rated highly and whether or not it’s that’s a valid assessment.

On the face of it, the reasons seem pretty straightforward. The first: Melbourne prices have been stagnant for the last four years while much of the rest of the country has been in solid or boom-like conditions. Many have concluded house prices in Melbourne, until recently the second most expensive in the country, have more to gain than anywhere else.

The second is the widely forecast fall in interest rates this year. Substantial homes in Melbourne’s middle ring - especially the eastern suburbs, Bayside and some areas in the north west - have a lot to gain as falling rates give buyers more spending power.

Evidence of Melbourne property uptick

An analysis of auction results compared to Sydney is pointing to an improvement, with a healthy jump in clearances for the start of the year.

Secondly, over the last three months, we have noticed a jump in interstate investors being led by borderless, transaction-driven firms to Melbourne (and the Victorian regions, according to my Bendigo associate, Michael Kimbel).

Unfortunately, many of these investors are in our view, overpaying for their purchases.

What is the Melbourne trap?

Now, the bad news.

If you’re interstate and thinking of buying in Melbourne, you need to be aware of the “Melbourne trap”.

The trap is where investors buy an asset based on what they think is a low price point without doing serious analysis.

To understand the trap properly, we first need to understand the dynamics at play to a larger extent in Melbourne than elsewhere.

Beneath the surface, there have been fundamental changes in the Melbourne market.

Firstly, supply. Over the last 25 years, Melbourne became home to more migrants and overseas students than anywhere else.

That triggered a response in construction which saw 13 per cent more homes built in Victoria than NSW, despite the state having a population around 20 per cent smaller.

That extra supply has been touted as the reason Melbourne has underperformed. Yet this dynamic has been in place for two decades and for much of that time, Melbourne was either the number one or number two performing market.

But there are less apparent changes in the metro’s dynamics, some coming to the fore right now.

For one thing, the new federal cap on overseas students could see a major imbalance open up in the inner-city apartment market.

It will take a couple of years for the full extent of the drop to show up but already we can see new student visa approvals are falling.

A lot of the growth in Melbourne’s skyline has been due to residential towers, with much of the new supply coming in the form of small apartments and studios.

Fewer students mean those smaller units are starting to become harder to rent. Add in the state government’s increase in land taxes for non-occupying owners and this market could underperform for some time.

And it’s not just the CBD. Near many tertiary education institutions, there has also been a surge in small apartments in suburbs like Footscray, Brunswick, Carlton South, and Southbank.

The other part of the trap sees out-of-town investors buying freestanding homes at low price points in outer suburbs, like Melton, Officer, Lara, Clyde and Pakenham East.

While these suburbs are convenient for working families, they typically lack the multiple macro drivers that push properties to outperform over the medium to longer term.

A final point to consider is that while traditionally Melbourne absorbed most of its new residents in the south and east, in the 21st century, more of these people are headed west.

How to target the best Melbourne properties

While some market segments could find themselves oversupplied or lacking growth drivers, others look primed for great performance.

I wrote recently of three oddly shaped areas as the best places in Melbourne to target family homes. What these areas have in common is they are established, feature high residential amenity and are around the metro’s median price ($917,000 for detached houses).

They have the right macro drivers in place, a healthy mix of different buyer types and consequently, a relative scarcity of homes for sale.

Compare that to many outer suburban areas that lack macro drivers and therefore, relative scarcity. Interest rate cuts will come as a relief in these areas, but conditions for budget-stretched buyers will remain quite tight.

Indeed, if we get a few rate cuts to this year, the needle is likely to move right, bringing into focus homes a bit above the median price in suburbs like Essendon, Burwood, Doncaster and Cheltenham.

For units, it’s a similar story of relative scarcity given the changes to Melbourne’s dynamics.

Most obviously, investors need to avoid (high risk) off the plan and newer, smaller units.

For established units in areas with good macro drivers that haven’t featured heavy development, the picture is quite bright.

While much has been made of the exodus of mostly retired landlords from the Victorian market, what’s been less noticed is that many established units for sale have been snapped up by the surge in Victorian first home buyers as well as well-heeled investors.

In areas like Ascot Vale, Sandringham, Prahran and Caulfield North, well positioned locations close to transport, employment and lifestyle attractions still exhibit solid demand for units from different buyer types.

Investors should ignore stamp duty savings for newly built apartments and instead target established units with adequate size (say 46 sqm+) and where the underlying land value equates to between 40 to 60 per cent of the property’s sale price.

Yes, investors should take a close look at Melbourne, but to avoid the trap, they should only buy after applying localised due diligence.