Chinese investors are pulling out of Melbourne's apartment market, prompting a downturn.

Key points: Melbourne apartment market expected to face a downturn

Melbourne apartment market expected to face a downturn Chinese investors are losing interest in buying apartments in Melbourne

Chinese investors are losing interest in buying apartments in Melbourne Off-the-plan apartments being resold at a loss or no price growth

In the past, they helped drive the inner-city apartment market to new heights. Around 5,000 new apartments are expected to be completed and up for sale this year.

However, around 80 per cent of Chinese buyers will not be able to settle because of trouble getting finance, according to Ming Li, a real estate agent in Melbourne's eastern suburbs who specialises in selling Australian property to Chinese investors.

He said many of his clients had either forfeited their deposits or sold their apartments at a loss.

"The Melbourne apartment market is cooling down," he said.

"It is kind of the oversupplied market, and the Chinese investors are losing their interest in buying an apartment in Melbourne. The capital gains return is so low."

Another reason for the downturn relates to the Chinese government's restrictions on its citizens' ability to move money offshore.

"The Chinese government's new policies only allow Chinese individuals to transfer about US$50,000 overseas, per head per year," Mr Li said.

"If it is more than that amount, they need to submit [an] application to authorities, and it becomes harder and harder."

At the same time, Australian banks are tightening their lending criteria for offshore investors.

"If you look at apartment approvals, which is a bit of a reflection on apartment off-the-plan demand, they peaked 18 months ago, and [now] they have started to slow,' said Angie Zigomanis, BIS Oxford Economics property analyst.

"We did an analysis a little while ago looking at people who had purchased an apartment off the plan since 2011 and since resold."

Mr Zigomanis found that: "Sixty per cent of buyers who had purchased off the plan and then resold recorded either no price growth or a loss."

Citi has warned that the downturn in apartments will filter through to a 7 per cent price correction next year in the broader housing market.

Earlier this week, ratings agency Standard & Poor's (S&P) downgraded all 23 second-tier financial institutions, due to the increasing risk of a sharp correction in property prices.

The downgrade has prompted a furious reaction from the small banks, led by the Bank of Queensland (BoQ).

"Our market share — particularly in key markets that S&P are worried about, like Melbourne and Sydney — we actually have a very very small exposure into those key markets, so it doesn't make any sense at all," Jon Sutton, the CEO of BoQ, said.

Australian housing bubble

According to economist Philip Soos: "There certainly is a housing bubble in Australia. Since 1996, we've seen housing prices inflate above all known fundamentals, such as GDP, inflation, income, rents and population growth."

Australians are holding more debt than ever before.

"Australia has accumulated the world's second highest household debt to GDP ratio at 123 per cent and rising," Mr Soos added.

"All countries that have a ratio above 100 per cent have experienced or are currently experiencing a housing bubble."

Mr Zigomanis said prices had peaked, but that predictions of a sharp fall were wrong.

"We think prices can be justified by population growth, interest rates, demand and employment growth," he said. "In some ways, prices are priced to perfection."

"In the next two to three years, we don't see a big shock which will push prices down."

Mr Li certainly hopes so, as his new target is Chinese parents looking to migrate to suburbs with elite schools. He says they are willing to pay a premium of 10 per cent.

But if S&P's warning is correct, attracting premium prices is about to get a lot harder.