Vacancy First, Price Decline Second

Property investment is a very interesting space. Coming from a fixed income investment background, the obvious link to fixed payments, generated from rent less interest costs, on an asset spring to mind. Capital appreciation is usually included. Capital depreciation can also be considered: maintenance should be offset by rental payments.

Overall, this means that a property’s price has a mostly linear relationship with rental rates. If you are really looking at this, vacancy rate forecasts should also figure. Vacancy is a natural aspect of renting: customer churn and lack of demand all take their place.

Vacancy rates themselves create something interesting and we quickly start to see a complex relationship. Vacancy could occur from a high price: the property owner waits until a high-paying customer comes along and may have higher specification in the property. The vacancy rate could be naturally adjusted by lowering the rental price and we have an really interesting dynamic between price equilibria that can be saved for another day.

More concerning is that a decline in demand due to a shift in people wanting to rent for any price is also possible. Loss of jobs, a desire to buy and not rent or property investors not wanting to rent places out altogether as it may not be economical versus their view on capital depreciation.

A new Prosper Australia report suggests vacancy rates in Melbourne for Investment properties is over 20%. This causes a few concerns:

  1. Investors are short of demand or they are choosing not to rent out
  2. What is happening to rental prices: we would expect the to decline if there is an oversupply of rental property
  3. Has the investment case for property shifted from net rental metrics to pure capital appreciation

Our expectations is a mix of these and other factors. The greatest concern is the pure-play capital appreciation. If all the recents returns are due to capital appreciation, then we expect a higher level of selling if prices decide to flatten or decline: investors will want to lock in returns in uncertain times, such as a recession.

This also suggests a breakdown in investment thesis: leaving places empty, particularly apartments, means the land value is the main driver in price. We agree there is a grab for high quality locations but this may not be the most efficient allocation of capital. Watch this space.

Leave a Reply

Your email address will not be published. Required fields are marked *