Forecasting property investing returns: what can we expect?

Property investors should think about the investment returns they can anticipate over the next decade and beyond.

This process assists in shaping realistic expectations to make informed financial decisions.

It’s most advisable to create these expectations based on evidence and data.

The past decade has delivered below-average returns

The chart displayed below illustrates the rolling 10-year investment property returns starting from 1982.

These returns have been calculated using the average median house prices and rental figures from both Melbourne and Sydney.

To factor in all expenses except interest, I have adjusted the gross rental yields by reducing them by 30%.

There are a few noteworthy observations from this chart to highlight.

• Over the past 40 years, the average decade-long return was 9.7% p.a. consisting of 7.3% p.a. in growth plus 2.4% p.a. net rental income. The minimum decade-long return was 4.7% p.a. (1989-1999) and the maximum was 13.6% p.a. (1982-1992). Statistically, two-thirds of the time (66% probability), your decade return will range between 7.7% and 11.7% p.a. i.e., there’s not a lot of volatility.
• Growth and income tend to be negatively correlated in that if property investors experience a decade of lower-than-average growth, they will tend to be compensated with a decade of higher-than-average yield.
• The period between 2009 to 2021 resulted in below-average growth and income with a total return of less than 8% p.a., which is 20% below the long-term average. The market made up a bit of ground thanks to the recent Covid property boom and recent spike in rental yields.
• Decade-long investment returns have been below average since early 2018, except for a short period that ended in 2022. That suggests there is a strong likelihood that investors will enjoy mean reversion over the coming decade i.e., above-average returns to make up for recent below-average returns.

Rental growth has been subdued for many years

The chart provided below depicts the annualised rental yield growth rate over a rolling 10-year period for houses in Melbourne and Sydney.

Notably, rental growth has been below average for the decades ending between 2017 and 2023, encompassing the past 15 years.

This context helps us understand that the recent increase in rental income is a rebound from a period of underperformance in the market.

A period of rising income followed by rising values

There is a pronounced shortage of private landlords in Australia.

The national vacancy rate reached a record low, falling below 1% last month.

In the past year, median rents have surged by more than 10% in many states.

It’s highly probable that rents will continue to climb until there’s an increase in the number of private landlords/property investors.

As the number of landlords increases, there will be a greater demand for property, which is expected to lead to capital growth.

However, historical data suggests that experiencing above-average capital growth simultaneously with rising rents is unlikely.

Hence, it’s probable that the market will initially see rental growth in the short term, followed by a subsequent phase of capital growth.

Attracting more landlords: borrowing capacity

The first thing that must be changed is that borrowing capacity needs to be loosened.

Bank must impose a 3% buffer on top of prevailing interest rates to assess a borrower’s serviceability.

This means prospective loan commitments are calculated at 9.5% on a principal and interest repayment basis.

Put simply, an investor must demonstrate it has an annual surplus cash flow of over $67,000 after tax to borrow $1 million – that’s approximately $100,000 p.a. before tax.

The RBA cash rate would have to rise above 10% for this cash flow assessment to be a reality on an interest-only basis.

That is just not going to happen.

To make the assessment of borrowing capacity more logical, the benchmark interest rate should be capped, possibly at 9% on an interest-only repayment basis.

That would allow more individuals willing and able to invest in property to access sufficient borrowed funds to do so.

Attracting more landlords: potential investor incentives

If loosening borrowing capacity is not enough to resolve the rental crisis, then the government could consider offering CGT incentives to long-term landlords.

Here are a few proposed ideas:

• If you own an investment for more than 12 months and make a capital gain when you sell the investment, you are entitled to discount that gross gain by 50%. The government could provide a bonus CGT discount of 10% to 15% for landlords who make a property available for rent continuously for at least 10 years.
• The government could offer a concession to individuals who sell their investment properties and roll the capital gain into their superannuation. Australians invest in property to build retirement savings and more self-funded retirees reduce the burden on the welfare system. Similar CGT incentives are already offered under ‘small business CGT concessions’ allowing business owners to roll the capital gain from a sale of a business into super to avoid paying CGT.
• Lastly, the government could reinstate the general 50% CGT discount for Australian citizens who are non-tax residents working overseas. Presently, Australians working abroad are taxed on the full 100% of property capital gains for the duration they are overseas. Consequently, expatriates are hesitant to invest in Australian property. Further, banking lending policies tend to be very restrictive.

These suggestions should only be considered as a last resort. Generally, governments should resist intervening in a free market.

It is also preferable that property does not receive any preferential tax treatment.

However, the rental crisis must be solved, and if all other interventions have failed, then increasing tax incentives could be the lesser of two evils.

Property returns 2023-2033

Based on this analysis, investors could see an increase in yields over the next few years, but the expectation for capital growth is to remain below average, possibly in the range of 4% to 6% annually.

Nevertheless, as more investors enter the market, it’s likely that capital growth rates will pick up.

In short, it is likely that investors will be compensated with higher yields in the short term until they are eventually compensated with higher capital growth in the long run.

Given the relatively recent period of underperformance from 2009 to 2021, it wouldn’t be surprising if the average total returns from property investment exceeded 10% p.a. over the next decade, provided investor activity normalises, the economy maintains robust, and there’s substantial population growth.

About Stuart Wemyss Stuart was a Chartered Accountant before establishing mortgage broking firm ProSolution Private Clients. He has authored two books and shares his experience with readers of Property Update. Visit www.prosolution.com.au