Capital city home values rising while rental yield returns are declining: Cameron Kusher

Research by RP Data shows that while capital city values are climbing, rental yields began to decline and with further drops expected to emerge over the coming year.

Although value growth may be strong at the time when mortgage rates are incredibly low, once rates eventually increase, value growth can quickly slow which was evident in late 2009 and 2010.

While there are benefits associated with negative gearing, investors may like to look at the longer term costs and benefits associated with housing market investment rather than just speculating on a short-term capital gains. The problem with a strategy around purchasing for investment purposes in the current market 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. A feature rarely seen across the residential housing market is simultaneous growth in values and growth in rental rates.

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.

The September RP Data-Rismark Home Value Index covering capital city house values shows an increase by 5.7% over the past year while unit values increased by 4.4%. At the same time, rental rates increased by just 3.1% for capital city houses and 2.6% for capital city units.

Over the 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 was when home values fell through 2008, 2011 and 2012. Of note is that rental rates never fell on an annual basis over the period however, the growth was generally moderate.

Movement in gross rental yields over recent time shows that as home values experienced strong growth throughout early 2000, a significant deterioration in rental yields was evident. Since that time an improvement in yields during 2008 and 2011/12 can be seen as rental growth outpaced value growth. However, yields never returned to their previous highs. In recent times, gross rental yields have started to ease as growth in capital city home values outpaced rental growth.

There will always be 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 will 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.

Sales volumes estimates show that 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 homes purchased 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.

For Sydney, Melbourne and Perth, value growth over the past year has outstripped rental growth. Should this continue, 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.