With dwelling values substantially outpacing rents over the past six years, rental yields have been crushed to record lows in Sydney. Over the past five years, Sydney dwelling values have increased at four times the rate of rental increases, pushing yields to a recent record low of just 3.04% in July last year.  Since that time, Sydney dwelling values have been trending lower, falling by almost 5%.  With weekly rents only rising by half a percent since that time, yields remain only marginally higher relative to their record lows.

The average gross yield on a Sydney house is tracking at 2.96% and units are showing a slightly higher yield profile at 3.76%. Against this low yield profile, dwelling values are now falling on annual basis, down 3.4% over the 12 months ending April 2018.  The byproduct of low yields and negative annual movements in dwelling values is that Sydney’s total return has slipped into negative territory for the first time since the market was emerging from the Global Financial Crisis in early 2009.

Considering rental growth is sluggish across Sydney (dwelling rents were up only 1.2% over the past twelve months) and dwelling values are likely to trend lower over the coming months, I would expect the total return profile for Sydney to weaken further. 

While many investors tend to overlook weak yields, focusing more on the prospects for capital gains and relying on taxation policies to offset their cash flow loss, it’s surprising to see housing finance data indicating that investors still comprise slightly more than half of new mortgage demand across New South Wales. 

Investment across New South Wales peaked in early 2015. At that time, investors comprised almost 64% of new mortgage demand.  As macroprudential regulations impacted on credit availability and mortgage rates for investors, participation from this segment of the market has slowed but remains high from an historical perspective.  Over the long-term, investors have averaged 37.4% of new mortgage lending in New South Wales compared to their 50.2% currently.  Tighter credit policies for investors have been the primary driver of slowing Sydney’s exuberant housing market, however, considering the high concentration of investment based on the latest housing finance data, investors still seem to be attracted to the Sydney market despite its high buy in price, low yield profile and muted prospects for capital gains. 

There could be some further headwinds for investors as we approach a federal election sometime in the next twelve months.  It’s almost a certainty that debate around negative gearing policies and capital gains tax concessions will be front and centre.  With rental yields close to record lows in Sydney and Melbourne, and generally low across most capital cities, we could see investment confidence dented further during the campaign period and significantly reduced if these policies are changed. 

Considering investors still comprise roughly half of new mortgage demand in Sydney, and nationally investors account for 43% of new mortgage demand nationally, a further reduction in activity could prolong the housing market downturn.