Yield compression. It sounds like a brutal wrestling hold, but it could turn out to be more painful than that for housing investors.

In the past year, the average rent in Australia’s capital cities rose 0.7 per cent for a house and 1.6 per cent for a home unit, according to the monthly rental report from industry analysis firm CoreLogic RP Data.

That may be music to the ears of prospective renters, but to investors it should be a warning siren loud enough to perforate an eardrum.

While rental growth is slowing, prices are booming, particularly in the red hot markets of Sydney and Melbourne, where the great majority of investor activity has been in recent months.

The latest weekly report from Corelogic RP Data showed prices rose an average 11.6 per cent over the year to last week in the five mainland state capitals, with Sydney up 17.9 per cent and Melbourne up 12.8 per cent.

As a result, the rental yields – rents as a percentage of the property values – have been falling. This is what’s known as yield compression, as yields are squeezed by rising prices on one side and slowing rental growth on the other.

The average rental yield on residential property was just 3.5 per cent in July, down from 3.9 per cent a year ago and the lowest yield in 20 years of data collected by CoreLogic RP Data.


A yield of 3.5 per cent before expenses and tax is low by any measure, barely covering consumer price inflation.

So any genuine investor buying property, or even not selling, must be expecting their return to come from somewhere else.

And that somewhere else is capital gain.

“From an investment perspective it means that capital growth is going to be much more important for a return on investment,” CoreLogic RP Data head of research Tim Lawless said.

And the need for capital gain to make up for low rental yields will only become more pressing as investors buy or build new housing.

The increased supply is pushing vacancy rates up in the key market of Sydney, according to a report from the Real Estate Institute of NSW.


“We expect this growth in rental accommodation to continue as even more new stock enters the marketplace,” REINSW president Malcolm Gunning said.

HSBC’s chief economist for Australia and New Zealand, Paul Bloxham, says the building boom will continue despite regulatory attempts to rein it in, driven by expectations of capital gains, foreign demand and low interest rates.

And that will push the problem further down the road, where it will be even harder to find a rational argument to support residential investment. But it’s hard to cool an exuberant market.

“Such is their nature,” Mr Bloxham said. “Capital gains beget more capital gains until one day, prices fall.”


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