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Kelvin Davidson: How long can rental growth stay this strong?

In the aftermath of 2020’s COVID-related freeze on rent increases, it was always likely that there’d be a period of ‘catch up’ growth, which inevitably came through. However, as time has gone by, it’s become clear that this run of strong rental growth is more than just a catch-up phase. What’s driving it, and how long can it continue?

To be clear about where we currently stand, the latest data (from MBIE’s rental bonds system) shows that rents in the three months to March averaged $521 per week, up by 7.0% from $487 a year earlier (which itself was up 4.7% from the figure of $465 in the three months to March 2020).

The growth in Auckland has been a little slower – 3.7% annually in the three months to March – while Christchurch (6.7%) is roughly in line with the national figure, and Dunedin has been a bit above it (7.6%). Other areas to have seen even stronger rental growth of late include Waimakariri (10.0%) and Queenstown (11.6%), as examples. Wellington City has the highest average rent, at $619 per week, followed by Porirua ($615), Auckland ($591), Lower Hutt ($562), Tauranga ($561), and Queenstown ($556). The lowest rents are in Westland, at $308 per week, and Waimate ($312).

Clearly, given that the long-run average for rental growth on this series is about 4% per annum, landlords currently have the upper hand when it comes to pricing. Indeed, the supply and demand balance remains fairly tight in the rental market, and at the same time, landlords will no doubt be looking to recoup higher costs such as mortgage interest and tax (i.e. the phased removal of interest deductibility). These motivations for landlords aren’t about to dissipate anytime soon.

However, the track record also shows that, over the long term, rental growth tends to be closer linked to wage growth than landlords’ costs – in other words, what tenants can afford to pay, not the bills faced by the investor. Indeed, many landlords would prefer to keep rents flat or only increase them modestly, in order to keep a good and reliable tenant.

Therefore, this strong upswing in rents is probably starting to look a little long in the tooth (e.g. rents as a % share of average household income are already at record highs), and we wouldn’t be surprised if growth needs to slow soon in order to keep tenants where they are, rather than perhaps moving out and bunching up with other tenants, thereby leaving more properties vacant.

So what can investors do? If rental growth dissipates and capital gains have also vanished (or even gone into reverse), clearly cost-control is important, while a focus on new-builds – given their tax advantages – could also be a winner. But looking at areas and property types with high yields also makes sense. Nationally, gross rental yields currently sit at 2.6%, while in Auckland they’re at 2.0% – but Christchurch still delivers >3%.

Other areas to note in terms of gross rental yield at present include Clutha (4.1%), Timaru (4.0%), Invercargill (3.8%), Ashburton (3.8%), and Whanganui (3.7%). Each of those areas has also delivered strong rental uplift in the past year, ranging from 9% in Ashburton, to 12-13% in Timaru, Invercargill, and Whanganui, with a rapid 18% in Clutha.

Ultimately, it’s likely that the largest increases in mortgage rates are behind us, and even though we’re now in a rocky period for property values, another upwards cycle will inevitably begin long-term. There’s no evidence of investors selling en masse, it’s just that there are tougher times to get through over the next 12-18 months.

Kelvin Davidson

Kelvin Davidson is the Chief Economist of CoreLogic New Zealand.

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