Residential Real Estate Market is Setting Records in Different Ways

The current Residential Real Estate market is setting records in different ways.  Until recently, prices have been at record highs, the consequence of sustained and substantial increases over the past few years.  The interesting thing is that this has only happened for prices, not rents.  In the same time that prices increased by 40%, rents moved by only about 10%.  How can this be?

The answer lies mainly in the difference in their driving force.  Simply, prices are only limited by the capacity to borrow while rent is subject to the ability to pay.  This is the area that has given rise to an unprecedented disparity.  Borrowing is controlled by interest rates, the willingness to lend and the desire to borrow and buy.  All have worked in the same direction.  With interest rates at long-term low levels coupled with keen and generous bank meeting up with a good dose of FOMO (fear of missing out), both owner occupiers and investors have been chasing the market up.

On the other side, rent is inextricably linked to salaries, now meandering along at about inflation levels of 2% per annum.  In spite of strong company profits and relatively low unemployment, wages are stuck in a deep rut.  The combination of these two markets means that typical rental investment returns have declined by about 30% – from about 3.5% to about 2.5%.

Where will things go from here? If we are ever to return to the average position of the past, then prices would have to fall by 30%, or rents rise by about 40% or a path between.  Perhaps we are now in a brand-new world where things will not change much from where we are now.

I think we can all agree that wages are unlikely to skyrocket in the foreseeable future, that interest rates are more likely to rise than stay the same and that the banks are increasingly cautious.  The new demand paradigm could be FOPTM (fear of paying too much).  We are in interesting times.

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