With capital city home value growth now outstripping rental growth, gross rental yields are falling and will likely move lower over the coming year.
A feature of the residential housing market is that you rarely experience growth in values and growth in rental rates at the same time. Given that yields are based on rental rates and home values, if values rise quicker than rents you will see an erosion of rental returns.
According to the RP Data-Rismark Home Value Index, capital city house values have increased by 5.7% over the past year and unit values have risen by 4.4%. In contrast, rental rates have increased by just 3.1% for capital city houses and 2.6% for capital city units.
As the first chart shows, over recent years, the annual rate of rental growth has seldom outpaced the annual rate of home value growth.
The two instances in which this has occurred has been when home values fell through 2008 and when they fell through 2011 and 2012.
It is interesting to note that rental rates have never fallen on an annual basis over the period however, the growth has generally been quite moderate.
The second chart highlights the movement in gross rental yields over recent times. The data shows that as home values experienced strong growth throughout the early 2000’s there was a significant deterioration of rental yields.
Since that time you can see an improvement in yields during 2008 and 2011/12 as rental growth was outpacing value growth however, they have never returned to their previous highs.
More recently, gross rental yields have once again started to ease as growth in capital city home values has outpaced the growth in rents.
As always there are some discrepancies between the performances of rental growth across individual capital cities. If we firstly look at the annual change in major capital city rental rates we see that the general trend is that rental growth is either slowing or quite sluggish.
Rental growth for homes across the major capital cities over the past year has been recorded at: 3.6% in Sydney, 2.1% in Melbourne, 2.3% in Brisbane, 2.5% in Adelaide and 4.6% in Perth.
At the same time 12 months ago, the annual rental growth figures were: 2.0% in Sydney, 1.2% in Melbourne, 2.5% in Brisbane, 0.3% in Adelaide and 11.4% in Perth.
According to RP Data estimates of sales volumes over the three months to July 2013, sales were higher across each major capital city than over the same period the previous year.
As the number of purchasers of homes increases this should alleviate many of the rental growth pressures present in the market, reducing the scope for investors to significantly lift rental rates, given this the outlook for rental growth is that although it may continue to rise, it is likely to do so at a moderate pace.
The final chart shows that across Sydney, Melbourne and Perth over the past year, value growth has outstripped rental growth. Should this continue (as we anticipate it will) there will undoubtedly be a further deterioration of rental yields.
In Brisbane and Adelaide rental growth has marginally outperformed value growth however, the gap has narrowed significantly over the year.
With values anticipated to continue to increase in Sydney and Melbourne and the potential for value growth to accelerate in Brisbane and Adelaide over the coming year, we should expect further erosion of rental yields.
With investors so active in the current market it is clear that most will be banking on capital gains for a return on their investment. The problem with this strategy is two-fold, firstly capital gains as opposed to rental return is not realised until the point of sale.
Secondly, although home value growth may be strong at a time when mortgage rates are incredibly low, once rates eventually increase, value growth can quickly slow as we saw in late 2009 and early 2010.
Should this occur, investors may be left with a low yielding asset. Of course there are benefits associated with negative gearing available however, investors may like to look at the longer term costs and benefits associated with housing market investment rather than just speculating on short-term capital gains.