Observations of Australias Rental Market

October 2013

Key Points:
The rate of rental inflation surged in the early stages of the Global Financial
Crisis and has subsequently remained above its two decade average.
Vacancy rates in the rental market remain historically tight, but are starting
to drift upwards.
There is a very strong linkage between interest rates and rental price
inflation, with the two variables generally moving in tandem.
High levels of net migration from overseas have also boosted rental growth
in recent years.
Mortgage financing constraints in the post-GFC era have prevented some
households from purchasing their home, fuelling rental increases.
Recent economic uncertainty has tilted some households away from home
purchase and towards the rental market.
Any restrictions on negative gearing or other taxation policies affecting the
rental market are likely to lead to significant rent increases and may
exacerbate supply constraints.
It is likely that rental price inflation will remain relatively brisk for the
foreseeable future.
Developments in the rental market are an important driver of activity in the residential
construction market. In the owner occupied segment of the market, the level of rental
costs will be an important influence on the decision to build or purchase a home.
Similarly, rental incomes act as a crucial determinant of investor activity, with higher
rental returns providing higher incentives for investors to participate in the market.
Accordingly, developments in the rented sector of the market have an important
influence on the level of new dwelling construction and transactions in the market
generally.

Trends in rental inflation

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The chart below illustrates the growth in rental costs over the past two decades. There
has been some considerable variation in the growth over the years with both the early
1990s and the early 2000s being characterised by rather weak increases. From the
mid-2000s, the pace of rental increases accelerated and reached an annualised level
of nearly 9 per cent in late 2008. The pace of growth subsequently slowed but has
remained well above its long term average over recent years.

HIA Economics Group Note October 2013 Observations of Australias Rental Market

CPI Rental Growth Australia

Source: ABS 6401

2.5

9.0
8.0

% change in index

2.0

7.0
6.0

1.5

5.0

4.0

1.0

3.0
2.0

0.5

1.0

0.0

Qtrly

Jun-13

Jun-12

Jun-11

Jun-10

Jun-09

Jun-08

Jun-07

Jun-06

Jun-05

Jun-04

Jun-03

Jun-02

Jun-01

Jun-00

Jun-99

Jun-98

Jun-97

Jun-96

Jun-95

Jun-94

Jun-93

0.0

Annual

Trends in vacancy rates are shown in the chart below. Lower vacancy rates signify that the balance of supply
and demand is tighter. Under such scenarios, rental costs tend to accelerate. Vacancy rates came under
particular pressure through 2007, with an upsurge in rental inflation following. The advent of the GFC saw a
loosening of capacity in the rental market, but vacancies began to tighten again in late 2009. Latest data
indicate that the number of vacancies has been drifting upwards, although vacancy rates are largely steady.

Rental Vancancy Rate and Number of Vacancies, 2005 to 2013

Source: SQM

40,000

3.0%
2.5%

35,000

30,000
1.5%

25,000
1.0%

20,000

0.5%

15,000

Vacancy Rate (LHS)

Aug-13

May-13

Feb-13

Nov-12

Aug-12

Feb-12

May-12

Nov-11

Aug-11

May-11

Feb-11

Nov-10

Aug-10

Feb-10

May-10

Nov-09

Aug-09

May-09

Feb-09

Nov-08

Aug-08

Feb-08

May-08

Nov-07

Aug-07

May-07

Feb-07

Nov-06

Aug-06

May-06

Feb-06

Nov-05

0.0%

Aug-05

Vacancy Rate (%)

2.0%

No of Vacancies (RHS)

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HIA Economics Group Note October 2013 Observations of Australias Rental Market

Interest rates
The level of interest rates has a significant influence on activity in rental markets. This is because changes in
rates affect the attractiveness of renting relative to home purchase. Higher interest rates cause mortgage
servicing costs to increase, something which will render renting more advantageous. This will boost the
demand for rental accommodation.
Interest rate rises will also increase the cost to investors of holding rental properties. Accordingly, increases in
the mortgage rate will tend to be passed on in the form of rent increases. Combined with the higher demand
for rental accommodation, higher interest rates will tend to cause rental prices to increase. Similarly, interest
rate reductions will tend to dampen rental price growth.
The chart below bears this relationship out. Over the past twenty five years, rental price growth and mortgage
interest rates have moved almost in perfect tandem. The only significant divergence between the two
variables occurred during the early stages of the GFC, due to the influence of another important factor net
overseas migration which is discussed in the next section.

Rental Price Growth and Mortgage Interest Rates

Source: ABS and RBA

18%
16%

14%
12%
10%
8%
6%
4%
2%

Jun-86
Mar-87
Dec-87
Sep-88
Jun-89
Mar-90
Dec-90
Sep-91
Jun-92
Mar-93
Dec-93
Sep-94
Jun-95
Mar-96
Dec-96
Sep-97
Jun-98
Mar-99
Dec-99
Sep-00
Jun-01
Mar-02
Dec-02
Sep-03
Jun-04
Mar-05
Dec-05
Sep-06
Jun-07
Mar-08
Dec-08
Sep-09
Jun-10
Mar-11
Dec-11
Sep-12
Jun-13

0%

Mortgage Interest Rate (Standard Variable)

Rental Price Growth (%)

Demographic change
The composition of the population has a crucial bearing on developments in the rental sector. Strong growth
in Australias population over the past decade has increased the demand for housing, both for purchase and
for rent. Strong increases in dwelling prices and rents have resulted, particular in the context of relatively low
levels of new housing supply.
The fact that transaction costs in the rental market are far lower than in the home purchase market makes the
rental market particularly attractive to newly arrived migrants from overseas or interstate. The chart below
shows how rental inflation has tended to strengthen as overseas migration inflows increase. The relationship
is not precise, but times of subdued overseas migration levels have tended to be accompanied by declines in
real rental values.
The surge in migration from overseas which occurred during the early stages of the GFC is likely to have
been a significant factor behind the strong upsurge in rental inflation at this time. This was the only occasion
in recent decades in which declining interest rates were accompanied by accelerating rental inflation. The
subsequent fall-off in rental growth coincided with a sharp decline in overseas migration.

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HIA Economics Group Note October 2013 Observations of Australias Rental Market

Real Rental Price Growth and Net Overseas Migration, 1988 to 2013
Source: ABS

7%

350

6%

300

5%
4%

250

Thousands

Annual Change (%)

3%
200

2%
1%

150

0%
100

-1%
-2%

50

Real Rental Price Growth [LHS]

Mar-13

Mar-12

Mar-11

Mar-10

Mar-09

Mar-08

Mar-07

Mar-06

Mar-05

Mar-04

Mar-03

Mar-02

Mar-01

Mar-00

Mar-99

Mar-98

Mar-97

Mar-96

Mar-95

Mar-94

Mar-93

Mar-92

Mar-91

Mar-90

Mar-89

-4%

Mar-88

-3%

Net Overseas Migration [RHS]

Rental costs and incomes

Household incomes are a key determinant of demand in the economy and the rental market will tend to reflect
changes in income. The chart below illustrates the relationship between rental costs and incomes (as
approximated by Average Weekly Earnings) over the past two decades. It is interesting to note that the
balance between the two has remained within a relatively narrow band over this period, indicating that the
proportion of income absorbed by rental costs tends to remain quite stable over time.
From around 2000 to 2006, income grew at a consistently stronger rate than rental costs resulting in a
sizeable decline in the household rental burden. However, the insufficient supply of new housing started to
make an impact from 2007 onwards. From this period onwards, rental costs as a proportion of household
income have increased. Relative to incomes, rental costs are about 5 per cent cheaper today compared with
two decades ago.

Relationship between Rental Prices and Average Weekly Earnings, 1994 to 2013
Source: ABS

200

150

100

50

Nov-94
Apr-95
Sep-95
Feb-96
Jul-96
Dec-96
May-97
Oct-97
Mar-98
Aug-98
Jan-99
Jun-99
Nov-99
Apr-00
Sep-00
Feb-01
Jul-01
Dec-01
May-02
Oct-02
Mar-03
Aug-03
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Oct-07
Mar-08
Aug-08
Jan-09
Jun-09
Nov-09
Apr-10
Sep-10
Feb-11
Jul-11
Dec-11
May-12
Oct-12
Mar-13

Index: Nov 1994 = 100

250

Rental Prices

Average Weekly Earnings

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HIA Economics Group Note October 2013 Observations of Australias Rental Market

House prices
The alternatives of home rental and purchase represent substitutes, with prices and other conditions in one
market having a strong influence on demand and supply in the other market. For example, as house prices
increase, the option of rental will tend to become more affordable and this will result in demand increasing in
the rental market. In turn, this will tend to force rental costs to rise. Higher rents boost returns to landlords.
From an investment perspective, this may result in greater demand from landlords and generate higher house
prices. Similarly, weaker house prices will tend to swing demand away from rental resulting in more subdued
rental price inflation.
The chart below provides a picture of the ratio between house prices and rental costs. Over time, house
prices have grown considerably faster than rental costs. This has led to a permanent reduction in the ratio of
rent to house prices (known as the rental yield). The reduced rental yield has taken place against the back
drop of a significant decline in long term interest rates. This means that the net rental return (after interest
costs) has remained fairly steady and that the rent-price balance remains in equilibrium.

Relationship between Rents and House Prices, 1986 to 2013

Source: ABS

120

100

Index (June 1986 = 100)

80

60

40

20

Jun-13

Dec-11

Sep-12

Jun-10

Mar-11

Dec-08

Sep-09

Jun-07

Mar-08

Dec-05

Sep-06

Jun-04

Mar-05

Dec-02

Sep-03

Jun-01

Mar-02

Dec-99

Sep-00

Jun-98

Mar-99

Dec-96

Sep-97

Jun-95

Mar-96

Dec-93

Sep-94

Jun-92

Mar-93

Dec-90

Sep-91

Jun-89

Mar-90

Dec-87

Sep-88

Jun-86

Mar-87

Rent to Price Index

Financing conditions
The fact that a very significant portion of home purchases are financed through mortgage lending means that
financing conditions have an important influence on the number of home purchases. In situations where
finance availability becomes more constrained, would-be home buyers will become shut out of the market and
will have no option but to rent. Accordingly, we would expect to see stronger rental price pressures in
situations where financing conditions are more difficult. By the same token, abundant finance availability will
allow home buyers to exit the rental market. Rental price growth will tend to weaken in this situation. Higher
finance availability will also affect the rental market by fuelling stronger growth in dwelling prices.
The chart below illustrates the relationship between rental inflation and the number of mortgages issued for
owner occupied dwelling purchases. The relationship between the two variables is not precise, but there are
clearly some periods when a link existed. During the early 1990s, the number of mortgage-financed dwelling
purchases increased (with the purchasers apparently exiting the rental market), while rental price increases
dropped off very sharply.
During the credit crunch which occurred around the GFC, a sharp fall in lending for home purchase occurred
implying that a significant number of households in the rental market who would ordinarily have moved into
home ownership remained. Rental price growth accelerated during this period, although it is important to bear
in mind that a surge in migrations from overseas had a large influence here.
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HIA Economics Group Note October 2013 Observations of Australias Rental Market

Mortgage lending for owner occupier housing purchase has remained at low levels by historic standards over
the past three years. This means that there has probably been a significant increase in the proportion of
households renting their home compared with the pre-GFC era. Rental inflation has decelerated significantly
since the spike during the early days of the GFC. However, rental inflation in recent years has been much
higher than over the last two decades. This reflects to some degree the pressures created by large numbers
of households being shut out of the home purchase market due to financing constraints.

Owner Occupier Mortgage Loans and Rental Price Growth, 1986 to 2013
Source: ABS

Owner Occupier Mortgage Loans [LHS]

Jun-13

Jun-12

Jun-11

Jun-10

Jun-09

Jun-08

Jun-07

Jun-06

Jun-05

Jun-04

Jun-03

Jun-02

Jun-01

0%

Jun-00

Jun-99

2%

Jun-98

20

Jun-97

4%

Jun-96

40

Jun-95

6%

Jun-94

60

Jun-93

8%

Jun-92

80

Jun-91

10%

Jun-90

100

Jun-89

12%

Jun-88

120

Jun-87

14%

Jun-86

140

Rental Price Growth [RHS]

Taxation policy
Taxation policy has an important role in determining levels of supply and demand in the rental market. The
arrangement whereby investors can deduct mortgage interest and other expenses from taxable income
effectively acts as a discounted borrowing rate for the acquisition of rental properties. The strong linkage
between interest rate changes and rental inflation means that the deductibility of rental expenses (including
negative gearing) results in rents being lower than what they would be in its absence. Any restrictions on the
taxation regime relating to rental properties are therefore likely to force rental costs to increase, significantly
reducing affordability in the rental sector.
Sentiment and uncertainty
Households will tend to be more averse to home purchase when there is perceived to be a risk that economic
conditions will worsen considerably. This is because home purchase represents a bigger commitment than
renting. Also, borrowing for home purchase is much less attractive in situations where a households income
is a risk and where job security is at issue. This means that conditions of poor consumer sentiment, rising
unemployment and slowing economic growth will tend to switch demand toward the rental market and away
from home purchase. There are elements of this dynamic currently in play, dominated by unemployment
expectations and related job security concerns.
Future Developments
Our analysis shows how movements in rental prices are strongly determined by interest rate movements,
migratory trends and economic prospects. Over the next year, interest rates are likely to remain largely
steady. Net inward migration will remain strong, though at lower levels than during the early part of the GFC.
Economic growth will slow further and financing conditions remain restrictive, while new housing supply will
be of an insufficient magnitude to redress the shortage of dwellings.

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HIA Economics Group Note October 2013 Observations of Australias Rental Market

Conclusions
-

Rental price inflation in Australia is currently rather high, although it has slowed since spiking in the
early stages of the GFC;

Strong price growth has coincided with low vacancy rates;

Interest rate developments are a crucial driver of rental price changes. The two variables tend to move
in proportion to one another;

Net overseas migration represents a very important demand driver in the rental market. The strong
levels of inward migration over recent years have contributed to higher real rental price growth,
particularly in the context of housing supply restrictions;

Household income and rents tend to track one another over time. However, the proportion of earnings
used to cover rent has increased in recent years. This partly reflects the poor supply response of the
new dwelling construction market;

House prices have grown considerably faster than rents over the past two decades. However, the long
term decline in interest rates over this period means that this divergence is not unwarranted;

Financing constraints post-GFC has forced some households to remain in the rented sector longer than
would have been the case pre-GFC. This has contributed to higher rental inflation in recent years;

More restrictive taxation policies, relating to negative gearing for example, would have the effect of
increasing rental costs further. Supply conditions in the rental market would also be adversely affected;

Economic uncertainty and low levels of consumer sentiment induce householders to hold off home
purchase. This leads to pressures intensifying in the rental market, with rental costs and vacancy rates
being squeezed;

Future developments in the rental market will rest on interest rate developments, the economic outlook
migratory trends, and the rate at which the recovery in new housing supply occurs. On balance, it
appears that rental price growth will remain relatively brisk for the foreseeable future.

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