Background Notes for Opening Remarks to Inquiry into Housing Affordability in Australia 4. The Rental Market

The rental market is currently very tight right around Australia:

• Vacancy rates are very low, at less than 1½ per cent on average across Australia (Chart 12); and
• Rents are rising quickly. In the past year, newly negotiated rents rose by about 13 per cent, while all rents outstanding (as measured in the CPI) rose by about 7 per cent (Chart 13).

Why has this happened, and why isn't more investment in rental housing taking place?

To answer these questions, we need to look back to the start of the housing boom in the mid 1990s. At that point, commonly used measures of gross yields on rental properties were in the order of 5–6 per cent. Over the subsequent decade, rents rose much less than dwelling prices, so that rental yields fell to relatively low levels – about 3 to 4 per cent (Chart 14). During this period, investment continued to flow into rental properties, as investors anticipated that capital gains would more than compensate for the low yield.

However, once it became clear that dwelling prices may no longer keep rising, the rental yield by itself was not sufficiently attractive to sustain the rate of investment, and the vacancy rate started to fall.

Even though rents have been rising quickly recently, over the longer term the cost of renting has risen less than the cost of buying a home (Chart 15). The price signals are therefore pushing households towards renting. On the other hand, the price signals facing investors are not conducive to increasing the supply of rental properties, as yields remain low and the prospects of capital gains uncertain.

It is hard to see how equilibrium can be restored to the market until rental yields return to more normal levels. One way for this to be achieved would be for house prices to rise more slowly than incomes and rents for a period. Measures that lower the cost of adding to supply of housing, particularly low-cost housing, would be helpful in aiding the transition process. This includes initiatives, such as that announced by the Australian Government in March, to help increase the supply of rental properties by giving tax subsidies to institutions investing in rental property.