October 23, 2024 by Dymphna

What actually drives the rent cycle?

Nope. Rates don’t matter.

One thing you’ve been hearing a bit lately is that the reason why rents are so high is because interest rates are high.

Higher interest rates affect the borrowing costs of investors, and so investors will pass those costs through to renters.

I can see the logic here, but this is not how the market works.

Rental prices are set by supply and demand, with most of the action on the demand side – how many homes people want and how much they’re willing to pay for them.

Rates make a difference at the margin, but most investors will just set rents at market prices – whatever they can get in the market – regardless of what they’re borrowing expenses are.

The RBA released a report last week that was making this point (effectively saying, please don’t blame us for higher rental prices!)

They do note that there is a correlation between rates and rental inflation:

But correlation is not causation:

Property investors cop the brunt of rising interest rates, according to new Reserve Bank research that debunks the idea that greedy landlords simply pass on higher mortgage costs to their tenants via rent increases.

For every $1 increase in home loan interest repayments, property investors raised rents by just 1¢, the RBA found after analysing 13 years of investor tax returns from 2006-07 to 2018-19.

“To put this effect in context, the median monthly interest payment for leveraged investors increased by around $850 between April 2022 and January 2024,” RBA economists Declan Twohig, Anirudh Yadav and Jonathan Hambur said in research released on Thursday.

“Our estimate suggests that this $850 increase in interest costs would have raised rents by less than $10 per month, or just over $2 per week.”

Under the RBA’s largest estimate, investors raised rents by just 3¢ for every $1 increase in mortgage interest repayments.

To look at what’s driving rental prices, you are much better off looking at the vacancy rate, which is also tightly correlated with rents.

The tighter the rental market, the higher rental prices will go.

And look, as an investors, I’d love to say that when my borrowing costs go up, I just pass that on to my tenants. I wish it were that easy!

But it’s not. I’m a price taker in the market. My tenants pay market rates.

And if that doesn’t cover my costs, well that’s on me. That’s part of the art of investing – making sure you’re not losing money!

But this is what determines rents. It’s the market.

Interest rates have very little to do with it.

DB