The gradual rebound of residential rental yields: Tim Lawless

Looking at the historical growth cycle of capital city rents and value growth, it has been quite a rare occurrence for weekly rents to outpace dwelling values for growth.

In fact, since 1996 there have been only two periods where weekly rents significantly outpaced dwelling values. The first of these occasions was during the GFC when dwelling values fell by close to 5% and rents rose by almost 8%.  The second period was during the recent housing market correction which ran from late 2010 through to mid-2012.

Both cycles gave yields a chance to regain some of the lost ground that was eroded over the previous growth cycles.

The most significant erosion of rental yields took place between 1996 and 2004 when gross rental yields virtually halved. When you consider that dwelling values surged by 142% between the end of 1995 and the beginning of 2004 while rents rose by only 25%, it becomes quite clear what drove the destruction of high average rental yields in Australia.

The average gross yield across the combined capital cities moved from 7.8% in 1996 down to 4.0% by the beginning of 2004.  Gross yields reached a low of 3.6% towards the end of 2007 through to early 2008 as value growth continued to outperform rents.

More recently capital city dwelling values are up 2.9% over the past twelve months compared with a 3.1% rise in dwelling rents. From a longer perspective, over the past five years weekly rents have increased by 27% while dwelling values have increased by a much smaller 10%.

With rents rising at a faster pace than dwelling values the by-product is of course an improvement in rental yields.  Gross rental yields for houses are currently recorded at 4.2% (up from a low of 3.5%) and the average gross yield on a capital city unit is 5.0% (up from a low 4.4%).

Looking across the capital cities, the current yield scenario is quite different from city to city.  Darwin is continuing to record the highest gross yields of any capital city.  The Brisbane housing market has quickly moved through the ranks to record the third highest yield of any capital city for houses and the second highest for units.

At the bottom of the yield pile is Melbourne where houses are returning a gross yield of just 3.7% while units are providing a higher 4.6% gross yield.

As can be seen from the graph below, the gross rental yield was on a consistent downwards trend since the 90s, however Melbourne’s spectacular rate of capital gains during 2007 and 2009/10 together with relatively sedate rental growth has conspired to cause gross yields to move lower than any other capital city.

With vacancy rates remaining around the 2-3% mark across most capital cities, it is reasonable to expect further and potentially greater upwards pressure on weekly rents.  This is likely to be particularly the case in those cities where new dwelling supply has been short such as Brisbane, Perth and Sydney.

While I doubt we will see capital city yields return to the highs last recorded in the 90’s, it is reasonable to presume we will see ongoing improvements in the yield environment across the Australian housing market. This scenario implies a continuation of subdued capital gains with a consistent over performance from rents compared with values; not an unreasonable notion.

Anecdotally a lot more of the investors I have been speaking with are considering tweaking the balance of their investment strategy; looking to maximise their yield while buying in locations where they expect the asset to show potential for long term capital gains.

Previously many investors were buying purely for capital gain prospects without a great deal of focus on the yield potential.  While capital gains are going to be the main strategy for the majority of investors, I wouldn’t be surprised if we see an ongoing focus on the rental side of the equation.

Tim Lawless is national research director of RP Data.