Why do rental yields go down as house values go up? Onthehouse's Eliza Owen

Why do rental yields go down as house values go up? Onthehouse's Eliza Owen
Why do rental yields go down as house values go up? Onthehouse's Eliza Owen

On Thursday, 26 June, a parliamentary inquiry into housing affordability in Australia began.

In spite of a lack of housing supply in Sydney and Melbourne to keep up with demand, rental yield return for investors is going down. There is a very simple explanation for this and yet it is something the Treasury officials struggled to account for last Thursday.

Onthehouse.com.au has data on rental yields for Sydney houses and units for over 25 years – which are plotted in Graph 1. Graph 2 plots the same data category for Melbourne. Both graphs display rental yields are falling over time.

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Why do rental yields go down as house values go up? Onthehouse's Eliza Owen

 

Click to enlarge

Why do rental yields go down as house values go up? Onthehouse's Eliza Owen 

I believe it is important to clarify why rental yields are falling, so as not to be convinced that it is somehow getting cheaper to rent in Sydney and Melbourne, because it is not.

The explanation is simple: ‘rental yields’ refer to the rental income received on a property as a percentage of what a house is worth.

As a primary school student will tell you – a fraction or percentage becomes smaller if you take the same amount of something from a larger total.

If I take a 10 cm2 area of cake from a 100 cm2 squared cake, I have taken 10% of the cake. To make myself seem less fat, I tell everyone the cake was 200cm2. Suddenly, my piece becomes just 5% of the cake, even though I have still consumed a 10cm2 area of cake. Genius. 

Rents in Sydney and Melbourne are rising. In fact, rent for the median house in Sydney rose 9.54% in the year to May, which is well above the 25 year average of 4.75%. However, the value ofhouses are rising even more rapidly. This means rental yields (measured as a portion of what the house is worth) are technically falling, but the real dollar amount that landlords are receiving in rent is generally going up. 

To get an idea of how real dollar values in rents are moving compared to house values, Graph 3 presents the increase in the index over time in values and rent in Sydney houses and units from 1990.

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Why do rental yields go down as house values go up? Onthehouse's Eliza Owen

An index of 5.36 in Sydney houses, for example, means houses are now 5.36 times what they were worth in 1990, which is the basis data point I’ve used. Graph 4 does the same for Melbourne.

Click to enlarge

Why do rental yields go down as house values go up? Onthehouse's Eliza Owen

It is clear from Graphs 3 and 4 that both dwelling values and rents are moving at a higher-than-average rate. This can be seen from the slope of the Index series. 
The important thing to remember about rents is that there is a lag in response to changes in the value of living in Sydney and Melbourne. This is because rents are negotiated (usually) over 6 to 12 month periods, whereas the value of houses and units change almost daily.

According to Onthehouse.com.au, the median rent for a house in Sydney is now $670 per week. While there is not a clear, consistent up-to-date measure of the median household income in Sydney from the ABS, the indexed figure from 2011 indicates that the median Sydney household income is around $1,123. This means that renting the median home in Sydney is over 50% of the median household income. Those below median earnings will struggle further with rents in Sydney.

Thinking about rental incomes in terms of rental yields is important for investors. It is an indication of how much income you could receive to cover things like mortgage repayments and property expenses. However, it is not a term which belongs in a conversation about housing affordability. Unfortunately, the Treasury does not seem to understand what rental yields are, let alone how to use them.

Eliza Owen is the market analyst for Onthehouse.com.au. She can be contacted here.

Jonathan Chancellor

Jonathan Chancellor

Jonathan Chancellor is one of Australia's most respected property journalists, having been at the top of the game since the early 1980s. Jonathan co-founded the property industry website Property Observer and has written for national and international publications.

Tags: 
Housing Affordability Inquiry

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