How can rent be rising while property prices are falling?

One of the many bizarre things happening in the Australian economy at the moment is the mixed signals coming out of the property market.

Rocketing rent tends to suggest that property prices should follow upwards, with higher rental yields naturally pushing up prices.

However, at the same time property prices have been dropping – down 2% in the three months to July, according to CoreLogic. And the trend indicates property prices are still falling.

So, how can rental prices rise by 9.8% in the year to July at a time of falling property values?

Lots of explanations for a perplexing problem

It is a perplexing puzzle, but there may be a few possible explanations.

One is that rising interest rates tend to boost investment yields. Most yield investments tend to be at a premium to the risk-free rate of return paid on government bonds.

Another potential explanation is increasing demand for rental properties – something supported by really low vacancy rates.

As international demand increases as the borders open and also because some landlords have moved from providing long-stay rentals to short-stay tourism accommodation.

There is also the possibility that a lot of renters who moved into their parents’ houses during the pandemic are back in the market.

Also likely is that the actual supply of rental properties has fallen as higher housing prices convince many older landlords to call it a day and cash in their chips. Increasing regulatory rental protections are also discouraging landlords.

Landlords facing higher interest rates are also likely to need to pass on those extra costs to their tenants, if they can get away with it.

Demand rising as supply falls – so up goes the rent

With demand rising and supply falling, it is not too hard to see why rents are rising – particularly as some aspiring home buyers give up and stay in the rental market.

However, it is inconceivable to imagine the current property divergence continuing for a very long time to come.

Just like negative bond yields (remember them?) the current circumstance smells like a strange situation that will eventually prove to be unsustainable.

Eventually, if rents keep rising, you would expect new property investors to be attracted to property sales and to start bidding up the price of houses and units, and in the process, reducing rental yields over-time.

Or, property prices could start to rise again after a brief dip, which would be amusing given the growing crowd of bank economists trying to outbid each other on how far property prices will fall.

Do we hear any bids above a 20% fall, are we all done?

Only mugs make definitive predictions

Like all markets, predicting future property prices is a mugs game, which was shown when the major banks all predicted large price falls during the COVID-19 pandemic and then had to watch in wonderment as big, double digit price rises arrived.

Anyone acting on their predictions would have been left nursing a roughly 40% difference in outcome, which is not a difference to be sneezed at.

If people who work in a bank with access to timely borrowing data can’t even get the direction of the market right, let along the magnitude of rises and falls, what hope do the rest of us have?

So, in this case the rising rent/falling property price scenario is something that should be regarded as highly unusual, but guessing the eventual resolution to reach mean regression and a “return to normal” is best saved for those who have a peerless crystal ball.

Could rising rents be reducing the property price downside?

One scenario that does tend to make some sense of the current divergence is that rising rent prices will be working to stabilise the falls on property values – both by encouraging those with means to move from renting to buying, and by attracting investors by keeping rental yields relatively healthy.

That would explain why some of the more recent predictions of double-digit price falls have not come about yet – or possibly even may not arrive at all.

In all of this interest rates remain another unpredictable variable, with some evidence that central banks are growing wary about causing a recession and might slow down on the interest rate hikes until the dust clears a little and the inflation numbers become clearer.

Eventually the diverging markets will come back into some sort of balance and with the benefit of hindsight we will all rue fortunes that we could have made or actual losses that we suffered.

Until then, those who watch the property market closely should strap in for what promises to be an interesting and volatile ride.