APARTMENT prices are falling in Australia’s CBDs and it is a major cause for alarm.

Prices in our major city centres dropped by an average of 6.3 per cent in the 12 months to July, according to CoreLogic figures.

Every capital city CBD posted a decline in growth but where the largest declines are coming from is even more telling. It is being driven by our two highest performing capital cities.

Sydney CBD apartment prices tumbled 9.1 per cent over the 12-month period while Melbourne CBD units dropped in price by 8.4 per cent.

A column in The Australian published on Wednesday cited a one-bedroom apartment in Melbourne recently selling for $161,000. The asking price for that $161,000 apartment in the general market would have been in the order of $550,000, the column claimed.

“Clearly, one seller was sick of the fact that their apartment was not selling and simply put it on the market for sale to the highest bidder,” the column read.

This is because we are seeing more and more large apartment developments coming into the market, prompting fears of an apartment oversupply.

The concern is amplified by the fact Chinese investors are largely the buyers of these new developments — regulation states offshore buyers can only purchase new real estate — leaving a “secondary apartment market” of property that sells way below the values investors are paying for off the plan.

“In the next six months many tens of thousands of apartments in Melbourne and around Australia that have been bought off the plan by Chinese and other Asian investors will come up for settlement,” the column stated.

But more stock keeps coming. REA Group Chief Economist, Nerida Conisbee, said the amount of development in some of our capitals is “eye watering”.

In Melbourne alone, there are over 18,000 apartments under construction that are scheduled for completion within the next 18 months, according to a REA Group analysis. Historically, Melbourne CBD has added 1500 apartments every 18 months for more than a decade.

Struggling first home buyers reading this may be rejoicing — and yes, it is good news for affordability — but it isn’t good news for the economy.

THREE STAGES OF RISK

There are three main risks facing the slumping CBD apartment market, Ms Conisbee told news.com.au.

The first one is settlement risk. This occurs when a buyer puts down a deposit for an off-the-plan apartment but when development is completed the bank won’t fund the loan because the value of the apartment has fallen, causing the buyer to default.

“Banks see it as risky or a bad investment [when prices drop],” Ms Conisbee said.

“Banks are now being restricted on the amount that they are lending, particularly to investors. They are being capped on the growth in their lending so they may see that particular apartment development as not being worthy of their lending. People have put down deposits two years ago ... but the banks can change their approach to risk quite significantly.”

This will leave an abundance of CBD apartments just sitting empty.

We are not seeing widescale defaults just yet, Ms Conisbee said, but there is “certainly a lot to be concerned about”, particularly in Melbourne and Brisbane given the amount of development taking place.

The second major risk is an occupational risk. A buyer may be approved funding when the complex is completed but they may not find anyone to live in the apartment.

“Such high levels of development will put pressure on rents and this is already happening in Brisbane and Perth CBDs,” Ms Conisbee said,

“While declines in rents are not great for investors, a large increase in the vacancy rate is even worse. No tenant equals zero rent, and therefore no return on investment.”

This could lead to the third risk: a secondary market risk. This is where you have a lot of offshore buyers snapping up these apartment developments because they can only buy new. But if they aren’t getting a good return on their investment what happens when they decide to sell?

“The likelihood of Australians buying the 18,000 apartments [in Melbourne] coming to market in the next 18 months; it is a far smaller pool. There is just potentially not enough people to buy those apartments,” Ms Conisbee said.

‘VERY WORRYING’

Widespread defaults and an oversupply of empty apartments will cause prices to plunge. And falling house prices leave our banks, who are highly leveraged in housing, hugely exposed — a “very worrying” outlook for the economy.

“It is seen as very worrying that a pretty small proportion of the economy, and a geographically small part of the economy, could have such a huge impact on Australian banks,” Ms Conisbee told news.com.au.

In its latest Financial Stability Review, the Reserve Bank said bank losses remain “very low” until price falls in inner-city areas reach over 25 per cent, which Ms Conisbee said is very unlikely. However, it does show that the banks “could lose billions” because of one small sector of the economy.

“If something really bad was to occur it could affect the stability of the banks and that is disastrous,” she told news.com.au.

But on the plus side, there is no denying first home buyers could finally catch a break.

“It is fantastic for affordability. People talk about an oversupply and in the same breath an affordability problem, but you kind of have to have an oversupply to lead to affordability. In terms of affordability it has been pretty amazing, so that is the flip side,” Ms Conisbee told news.com.au.

But increasing supply to increase affordability is only truly effective when we are building the right type of supply. And according to REA Group’s demand index, maybe we are not.

“In Melbourne, demand for houses is through the roof but demand for apartments is sitting on the Australian average,” Ms Conisbee said.