In the last video "Will Sydney's house prices crash?", I concluded that there is fewer market transactions, but house prices will not crash. The reason for this is that the rental return is now higher than the interest. From this perspective, it is now the safest period in the Sydney real estate market.
Some people may ask if the Sydney rental market will deteriorate, will this lead to house prices crash?
Summarising from the media reports, I have concluded 5 possible impacts the COVID-19 have on the rental market.
1. International students are not able to enter NSW due to states shutting their borders, resulting in a huge reduction in housing demand.
2. Travel bans on foreigner pushing short term rental accommodations to enter residential rental market
3. People relying on income overseas left Australia because of unemployment
4. Rent affordability dropped as the unemployment rate rises
5. Ban on open inspection resulting in a longer tenancy vacancy period
The key macro indicator for the rental market is the vacancy rate. Since the COVID-19 hits, the vacancy rate has indeed risen, from 2.5% to 2.7%. Is 2.7% high? It’s not. In the real estate industry, 3% vacancy rate marks the market equilibrium. What it means is that, on average, each property is vacant for 1.5 weeks over a 52 weeks period (per annum). If vacancy rate is less than 3%, it means the market is short in supply. As the average vacancy rate in Sydney has long been 2.7%, which means that the vacancy rate amid the COVID-19 epidemic remains the same as the average vacancy rate in Sydney. Therefore, there is nothing to worry about.
What if Australia failed to control the epidemic, will vacancy rate go up? What percentage will it be if it goes up? I’d prefer to let the reality tell as there is no point guessing.
Let us assume that the situation is very bad, say the vacancy rate has doubled, which is 6%. This has broken the historical record of Sydney's vacancy rate and this has never appeared before.
In such situation, will it lead to housing prices crash in Sydney? Let me pose a simple mathematical scenario for everyone.
Let us analyse the market from the landlord’s perspective. Say a person’s property worth $1 million, the current mortgage rate is 2.5%. If the bank lends 100% of the property value ($1 million), his annual interest payment is only $25,000, adding on the others miscellaneous fees which is $5000, and the total expenditure comes to $30000. At the current rental rate of 3.5%, the rent he can receive is $ 35,000 per year. If the vacancy rate is 6%, that is, he can only receive 94% of the rent, which is $32900. He can still pay all the expenses. As an independent landlord, he does not bare any financial pressure to sell his house at a loss.
This is a scenario for an individual landlord, and this is true for every landlord in the whole market. From a macro perspective, the overall economic situation of Australia's landlords will be even more optimistic. 35% of the landlords in Sydney do not owe money. Even for the new landlords who bought property in the recent years, most of them only borrowed 80% of the property value. Sydney landlords' average borrowing rate is less than 50%, generally around 40%. Therefore, in terms of the overall market, there is no way for the landlords to sell their property at a loss cheaply due to financial pressure.
Someone asked if the developers would sell property at a loss because of financial pressure? I can tell you this is not possible. If you’re interested in this topic, I can share more with you in the coming videos.
Therefore, from this perspective, anyone who is expecting a large scale of discounted sale from the landlords, they will be disappointed. The impact of the COVID-19 epidemic to the rental market has peaked in the past few weeks. The impact was due to the Government’s announcement on a six-month evictions moratorium, a ban on open inspection. This has given tenants a false expectation that they can skip their rental payment or having bargaining power over the rent payment. This aroused panic to the landlords. 30% of our tenants called in to ask for rent reduction. Since then the Government released clearer regulations - only those who have lost 25% of their household income due to the COVID-19 epidemic are eligible to negotiate rent reduction with their landlords, plus an implementation on eviction moratorium. However, the legal responsibility for the tenant to pay the rent remains in effect. Since a clearer regulation was announced, we have received no rent reduction request from our tenants anymore. What is more, since the Government announced the JobKeeper Payment Scheme, the number of people who are unemployed or who has 25% income reduction is much less than we expected. The landlord and tenant have now stabilized.
I can foresee that the negative impact of the COVID-19 epidemic on the rental market will diminish by the end of this year. If the Government does not open the border in the recent future, the Sydney’s population will not move. Therefore, the current housing demand is stable. However, given that there is currently very little new development, by next year there will be a shortage of supply.
If the Government gradually relaxes the ban, or conditionally allow international students to come in next year, there will be a serious shortage of supply in the market. By that time, not only the vacancy rate will drop, rent will rise as well.
My final conclusion is that the COVID-19 epidemic will bring negative impact in the rental market, but the extent of impact will not lead house prices to crash. At the same time, the negative effects will diminish and cease by the end of the year.
In the near future, we will hear unfortunate stories about the rental market on media report. For example, if some properties are vacant for two months, and still fails to find tenant. Some properties is only tenanted when the rent is a hundred dollar cheaper, or two hundreds dollar below market rate. Not only on the media reports, sometimes has this happened to us or friends around us.
What we discussed today is the overall market situation. To discuss whether the impact of the COVID-19 epidemic to the rental market will lead to house prices crash, it is important to analyse the issue from a macro perspective, rather than looking at individuals’ stories.
Finally, I have to remind everyone that when we talk about market risk, we cannot just comment that there is risk in general, we must conduct a thorough analysis of the risk and quantify the existing risk. If there is risks that cannot be clearly identified nor quantified, it is just fear rather than risk. If you want to understand the difference between risk and fear, you can read one of my English articles "how to overcome your fear for Property Investment".
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