“There’s a perception that rents are high now,” one of the country’s most highly regarded bankers tells me. “But rents are going to go through the roof once investors start to recognise that there won’t be significant capital gains from now on.”
This is unequivocally bad news for renters. They had been hoping that the sharp run-up in housing rents – which are on track to climb by at least 10 per cent nationally this year – might start to abate as the boom in house prices finally shows signs of tapering off.
Instead, it appears that we are at the beginning of a period of significant rental stress, as surging demand and a lack of rental stock have sent vacancy rates plummeting to a 16-year low.
Even worse, vacancy rates are expected to tighten further with the reopening of the international border and the resumption in migration and the return of foreign students.
But, the banker explains, there are financial factors at play which will also put upward pressure on rents.
“If you own an apartment, by the time you’ve paid strata levies, repairs and taxes, the returns are pretty meagre,” he says.
Until now, investors have put up with that because rising property prices have meant they have enjoyed strong capital gains. So, overall, it’s still worked out to be quite a good investment.”
But, he warns, this dynamic will change as rising interest rates cause home prices to stabilise – or even decline.
(In its latest Financial Stability Review, the Reserve Bank warned house prices could fall by about 15 per cent over a two-year period if interest rates were to rise by 2 percentage points.)
“If there’s no prospect of significant capital gains, investors will have to try to increase their returns through higher rents”, he explains.
“And you can see that already. Rents are already going up.”
What’s more, although lending to property investors nudged up by 3.9 per cent in the 12 months to February 2022, he points out that many property investors have been offloading their apartments.
“This is partly because investors have been taking advantage of high prices to sell, and partly a response to the eviction restrictions that were imposed during the pandemic, which made some investors decided that owning rental property wasn’t such a great deal any more,” he says.
“And for others, it’s a desire to reduce their gearing because they’re apprehensive about rising interest rates.”
Of course, rents are also soaring offshore.
In the United States, for instance, average monthly rents jumped more than 14 per cent in the year to December. In many major cities, including Austin, Texas and Miami, rents increased by more than 30 per cent.
As in Australia, the surge in US rents reflects a number of factors, including a shortage of housing inventory.
At the same time, many people who moved back with family in the early days of the pandemic are now flooding back into the rental market, boosting demand, and making it easier for landlords to increase rents.
In addition, after central banks slashed interest rates close to zero to soften the impact of the pandemic, many people decided to take advantage of ultra-low home loan rates to buy houses. As house prices surged, many people have been pushed out of the buyer market and into the rental market.
Landlords, meanwhile, are looking to claw back the drop in income they sustained during the pandemic when they offered discounted rents to entice new tenants, or when existing tenants missed rental payments.
Of course, people on lower incomes – such as hospitality and retail workers – are those hardest hit by soaring rents, which are rising much faster than their wages.
As the Reserve Bank noted in its April Financial Stability Review, “historically, renters have been more likely to experience financial stress than indebted owner-occupiers”.
The RBA added that “although renters are unlikely to pose direct risks to the stability of the financial system (as they have less debt), financial stress for renters could translate to repayment difficulties for indebted landlords or pose indirect risks by constraining household consumption and so economic activity”.
Of course, the surge in rents is already sparking calls for increased controls that would limit annual rental increases.
Rent controls have existed in New York since 1943, when the US government legislated a rent freeze in the city to fight wartime housing inflation.
Just under half of rental units in New York City are subject to rent stabilisation rules, which set the maximum rent increases, based on real estate costs and the cost of living.
But more US cities are now introducing rent controls.
Last October, local officials in Santa Ana, California, went further than the state’s rent controls which limit annual rent increases to 5 per cent plus local inflation. They decided to restrict rent increases in the City to 3 per cent for apartments built before 1995.
And in November, Minneapolis voters gave the green light to introducing the country’s most stringent rent control policies, which sets a 3 per cent cap on annual rent increases. What’s more, the controls also apply to newly constructed buildings.
Meanwhile, lawmakers in Miami and Tampa – where rents have climbed more than 30 per cent over the past year – have discussed declaring housing emergencies to introduce rent controls.
Landlords and the real estate industry are pushing back against rent controls. They argue that they discourage new apartment construction, which further chokes off the supply of rental accommodation.
And while such controls benefit people who have rental accommodation and don’t want to move, they act as a major disincentive for people to convert their properties into rental accommodation.
This makes it extremely difficult for new renters to find accommodation.
The other disadvantage is that rental controls discourage landlords from spending money on the upkeep of their apartments, which disadvantages renters.
Of course, it’s highly unlikely that Australian politicians would even contemplate riling mum and dad property investors by introducing rental controls, but rising rents will undoubtedly fuel social discontent, and increase the pressure on lower-paid workers to secure larger wage rises.
