Rents Outrun Values: Buy Time!

Yields are giving us a solid indication of which cities are ripe for the buying right now, and it’s not the cities you think.

On the property investor dashboard there are two main dials. Rents and prices. I like to think of it as a space-ship, but whatever floats your boat.

Now we spend a lot of time talking about prices. The media barely talks about anything else. But the truth of it is that rents, which are the year-to-year return on our investment, are just as important as prices.

Because rents are what determine our cash-flow position. And they can be one of the key brakes on expanding our portfolio.

That’s why a little research note from RP data last week was so interesting. It looked at the performance of rents and values together over the last 6 years – tracking growth into and out of the GFC.

And the results? In short, rents have out-paced values in a major way.

Since the end of 2007, house prices have grown 13.4 percent (on RP Data’s measure). For 5 and half years, combined capital house prices have not out-pipped inflation.

But at the same time, rents have grown 32.1 percent, almost twice the rate of house prices. Check out the graph:

The gap at the end reflects the (arbitrary) starting point, so don’t pay too much attention to that. What is interesting in this analysis is the widening difference in growth rates.

What that points to is a consistent improvement in yields. And so at this stage in the cycle, as house prices are coming back, increasing yields will make investment properties more and more attractive.

Which is why we’ve seen investors continue to be such an important part of the market. It hasn’t been the prospect of over-sized capital growth in the past 5 years that pulled investors to market. Rather it’s been superior yields, especially given the sour run the stock market’s had in recent times.

Breaking it down by city, it’s interesting to note that it’s not our major centres in the driving seat.

In Sydney, home values have increased by around 20 percent since the end of 2007, while rents have increased 35 percent. A moderately strong out-performance.

In Melbourne though, it’s neck and neck. Both have increased around 20 percent. This suggests to me, as I’ve been saying for a while, that the Melbourne market has its work cut out for it over the next 5 years or so, and will remain towards the bottom of investor wish-lists.

But the surprise story in this picture is Brisbane and Adelaide.

In Brisbane, house prices have actually fallen by 3 percent, while rents have grown 27 percent. This has opened up a huge gap between values and rental growth.

In Adelaide as well, house prices have grown just 7 percent, while rents have increased 21 percent.

There’s also a yawning gap in Perth, though this probably comes as less of a surprise. Home values as we know have been flat, growing just 2 percent since the end of 2007. However, rents have surged ahead, increasing 48 percent! This gives Perth the largest price-rent gap of all the capitals.

Now of course this differential on its own doesn’t give you a buy or sell signal. You need to anchor it to actual levels – actual returns and actual yields.

For example, you could argue, as I probably would, that the gap in Perth reflects extra rapid run up in prices prior to the GFC, and we’ve just had a period where rents were playing catch up.

But the signal the differential gives you about the direction of the market is useful. If rents are increasing relative to price, that means that returns are improving. If we thought that prices were overvalued, then we’re seeing a steady return to balance.

But if we thought prices were undervalued, then we’re seeing some excellent buying opportunities opening up.

With that in mind, this really piques my interest in Brisbane. Brisbane prices have gone nowhere for many years now. But we know that the population of Brisbane is surging, and SEQ is going to be one of the boom population regions over the next few decades.

And Brisbane didn’t have the kind of boom in prices that Perth did, so I think it’s difficult to make the case that prices in Brisbane were significantly over-valued prior to the GFC.

So I’d be getting out my magnifying glass and having a good hard look at Brisbane. If there has been a considerable expansion in yields, with interest rates at historic lows and the market turning, it could be the perfect time to buy.

And as it’s always the way, investors will lead the charge. Happy to wear a few years of middling price growth, investors will be attracted to the superior yields.

After the investors, come the owner-occupiers, who will take advantage of record low interest rates and a flat price market to upgrade into something a bit fancier.

Finally we’ll see the first home buyers. We would have normally expected them to make more of a splash by now. Especially given the cost of renting just keeps going up and up.

But then back in 2009 there were some pretty juicy incentives on offer for FHBs, which pulled a lot of demand forward, and largely explains the soft patch we’ve seen in recent years on the FHB front.

But we’re getting a few years ahead of ourselves. It’s the investors time. They’re the vanguard of the coming boom.

And for my money, if you don’t join them, I reckon in 12-18 months you’ll regret it.