Surging demand for rentals as borders reopen

Rental vacancy rates could fall to record lows as Australia finally reopens.

Unprecedented dynamics

Rental vacancies are set to fall to extremely tight levels as the international borders reopen. We are in a very unusual situation, with a huge backlog of arrivals waiting to enter Australia after two years of border closures, and in turn there is an opportunity for investors seeking both capital growth and rental returns, leading to strong total returns for landlords.

There have been a number of factors driving the looming rental shortage. We no longer have high volumes of investors from mainland China to drive the construction of new high-rise units, which has dampened the supply of new apartments.

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We also have an extremely strong population pyramid in Australia which is driving a surge in household formation. A substantial number of young renters have entered the rental market, as the lockdowns encouraged more renters to find their own space at the earliest available opportunity.

Figure 1 – Australia population pyramid

Now the borders are reopening further from February 21 and given that we have a backlog of two years’ worth of arrivals wanting to come to Australia, we can expect the snap-back in rental demand to be very strong in Sydney and Melbourne.

Indeed, SQM Research reported a very sharp drop to a 16-year low in the rental vacancy rate, driven by sudden sharp declines in Sydney and Melbourne in January. People are returning the work, now and this tightening trend has continued in February for both Sydney and Melbourne.

We can expect to see rental price growth rising into the 10 to 20 per cent range forthwith, with most rental markets around the country already experiencing very tight conditions.

Figure 2 – Rental vacancy rates in January 2022

Opportunities for investors

An increased demand for additional space has been a factor in the tightening rental markets. Many households have required office space to work from home, and wealthier households have taken the opportunity to buy second homes, which has depleted the available rental stock.

We are now seeing some opportunities in certain markets for investors in apartments to experience capital growth and increasing rents, leading to strong total returns. The unit to house price ratio is at record lows, reflecting that affordability for houses is becoming a challenge for many investors.

The rental supply is unlikely to respond quickly enough to the surge in demand for rentals, particularly in an election year when there is inevitably going to be level of uncertainty created by a potential change in government.

Opportunity hotspots

Some of the trends created by the unprecedented border closures and pandemic restrictions will be transitory, and therefore investors should look through short-term noise to focus on long-term fundamentals.

Investors should look through short-term noise to focus on long-term fundamentals

Investors seeking long-term capital growth and strengthening rental returns should focus on certain opportunities across the country.

In the unit market there are solid opportunities in many of the coastal markets on the eastern seaboard, including on the Sunshine Coast, as well as in Sydney’s northern beaches and eastern suburbs. Similarly in some of the suburbs in Melbourne’s inner south there are solid opportunities for investors.

Generally speaking, we look for boutique unit developments with reasonable strata levies, and if the budget permits, look for family-friendly units with owner-occupier appeal, in those popular suburbs where the supply is somewhat capped.

Reserve Bank of Australia research has previously shown that new migrants and arrivals to Australia tend to have only a limited impact on the housing turnover rate, because most new arrivals are renters initially, especially international students. That means a lot more demand for rentals is coming in 2022.

As the border reopens many parts of Australia will experience chronically tight rental markets.

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