Myth: Tight rental market boosts home prices

Fellow econblogger, Cameron Murray, has written a thought provoking post on his Blog about the link between tight rental vacancy rates and home prices. Cameron’s post has been re-produced below for your reading pleasure.

A common housing market myth is that low vacancy rates lead to rent increases, which lead to price increases (or at the very least, put a limit on any loss in home values). For example:

…this market imbalance will at some points cause an acceleration in rentals growth and a tightening in rental vacancies, so setting the stage for a recovery in prices through 2012.

Unfortunately, if history is anything to go by, this argument fails in real world conditions.

The two graphs below make the point clearly. In the early 1990s, vacancy rates soared and prices remained flat. But in the early 2000s, rental vacancies matched these highs during the strongest period of price growth observed in 25 years. How can these two opposing relationships been reconciled?

(The first chart is from here)

I have a hypothesis.  During boom times overbuilding results in a slight glut in homes entering the rental market (eg 2000-2005). As the construction boom subsides, these homes are slowly absorbed by rental demand. When the market begins to fall (bringing much of the economy with it) potential sellers become reluctant landlords, boosting rental supply (eg 1990-1995). Additionally, nervous householders reign in spending on housing, resulting in an increased occupancy rate and lower rental demand.

There are many ways the occupancy rate increases, which don’t necessarily imply a shortage of homes. Downsizing leads to more efficient use of existing homes:

For example, the parents of a family whose adult children have moved out with friends or partners might find that the upkeep of a large house conflicts with their ‘grey nomad’ retirement plans. They can sell their 5-bedroom house and move into a new 2-bedroom unit, pocketing the price difference for their retirement.

In this scenario the construction of a 2-bedroom apartment resulted in a 5-bedroom home being available to meet the housing needs of population growth.

Other ways include university students moving home with their parents, and grandparents moving in with their children’s families.

If my hypothesis holds, then the ‘rental market cycle’ has two periods for each economic cycle, and tight markets are a signal of a price boom only if the previous trough was prior to a price fall. Therefore our next ‘rental market cycle’ will be one accompanied by falling prices, or flat at best.  The evidence in Brisbane seems to suggest this pattern beginning to occur in Brisbane (although prices have already fallen 10%).

(I also have a suspicion that auction results show a similar cycle – increasing in booms and busts, with low clearance rates at turning points.)

Unconventional Economist


  1. Also, during a bust, it takes longer and longer (months/years) to sell a house that was previously rented out and is currently vacant.
    As the pile of unsold, unoccupied houses mount, it may temporarily pull down the rental vacancy rate, until the time investers capitulate and reduce to sell !!

  2. Nice logic. I have my own doubts over the actual vacancy rates or at least the demand for rentals. Having just gone through the rental application process after 18 months since last time (in Sydney), I had numerous encounters of agents calling me asking me to put in offers on places i’ve seen, places advertised for multiple weeks with large price drops to actually rent it out, and open houses with only a few people attending.

    The one place we did apply for we were basically automatically accepted, no reference checks or anything.

    Perhaps vacancy rates are low but renters are also down, so its not pushing up the price of rentals. This is a factor that doesnt seem to be considered when papers have headlines of “vacancy rate at 1%”.

    • I had this scenario when I was looking a year and a half ago. I’m in Melbourne.

      I also pay attention to what the other units in my block go for. All two bedroom apartments, decent sized, basically identical except whether they have been refurbished or have A/C. The price has remained steady and even dropped. If they ask for too much the price quickly drops.

      Also I have the occasional look to see what is avalible in my price range if I did want to change. There are more stock avalible then before and they seem to have better facilities then they did in lets say 2008.

      The drop in international student rentals could be a factor. Or gen Y staying at home more then they used to…

    • We also had a similar situation in Sydney’s East in the last month. We went and looked at houses just out of our price range but were encouraged by the agents to put in an offer. We made a low ball offer for a house just out of our price range and were accepted. We are now living in a rental which has been discounted by 20% from the original asking price. We had loads choice which has been different from any other time I have applied for a rental.

      • Maybe Macrobusiness needs to look at where these rental supply figures come from and if there is any figures to analyse the other side – Demand.

        Oh and our area is Inner West (Annandale)… if you believe the hype in SMH it is the most desirable spot in Sydney at the moment.

        • they probably base their rental demand figures on the number of homeless people. That is how they claim we have housing shortage

      • hmmm

        personally, i’m seriously starting to consider the idea of a rental price mini-bubble that precipitates the final leg down for the sales price bubble.

        Leith/Cam/MB and Co, it would be great if you guys could empirically investigate whether rental price downturns (possibly just following rental listings gluts, even following a sale price slowing/peaking/flattening) might precede a final sale price crash in countries such as USA, UK, Spain, Ireland, etc, etc, etc (might even be able to get state-specific for the USA…??)

        Just some thoughts.

        (I’ll admit to having a particular curiousity in this notion, as i’ve been calling a rental glut –> popping of a rental mini-bubble –> sales price leg down for a few months now….so i’m not without bias and interest!!)


    • started a tenancy in january this year, 4 bedroom house on quiet st 5km north of Brisbane cbd. Advertised for 420, I offered 400 and it was accepted. This never would of happened in 2008, people would be lining up to offer more than listed price. It was last sold August 2010 for 540k.

  3. “potential sellers become reluctant landlords” I can vouch for this one if whats going on the property market in my area is typical of whats happening across the country.

    Im seeing lots of houses that just wont sell for anywhere near what the vendor needs to clear the debt being turned into rentals while the owners wait for the market to pick up so they can offload these over priced houses. problem is this just creates a massive overhang in the market or shadow inventory that will ensure prices can’t rise becuase as soon as they do these properties will be up for sale. Problem for these dilussional owners is that they think the market will return to the peak last year but that was a once in a lifetime chance to sell that will not be repeated anytime soon. My advice to reluctant landlords would be to sell now becuase it aint getting any better and they will just be worse off down the track as these “negetively geared” properties suck their cashflow dry and when they are forced to sell at a later date they will just get less. Seems the property market doesnt “always goes up” afterall

  4. As a seller who became a reluctant landlord following the Irish residential property crash, I can provide anecdotal verification for part of the theory. It makes sense to me. A lot of these dynamics are not very intuitively obvious until you live through them.

  5. Good theory, I like it. It would help explain three things I have noticed in my current search for a rental after 18 months absence:
    1) An increase in the number of rentals available.
    2) A modest fall in prices from 18 months ago.
    3) The presence of higher-quality stock, that is, people who care about their home as a place to live in.
    Investment property is to chalk as Owner-occupied property is to cheese.

  6. Hello Leith, regarding your comment below…

    “I also have a suspicion that auction results show a similar cycle – increasing in booms and busts, with low clearance rates at turning points.”

    In fact there is some research by Macquarie, APM and RPData that shows the opposite. See charts below…

    Auction Results Correlation with House Prices

    Low clearance rates are historically associated with flat or falling house prices. High clearance rates are associated with rising prices.

    There is no evidence of high auction clearance rates during a bust…



    • Good point Shadow.

      BTW that was my comment about possible auction result trends.

      It seems that auction clearance rates are actually a pretty good indicator of price movements (in Sydney at least).

      Speaking of auctions, I would be interested in finding some data on the proportion of homes sold by auction in each city over time.

      • Hi Cameron, sorry… realised after I posted that it was your guest blog. (I’ve just posted the same comment over on your own blog site now).

        Actually the correlation holds true for Melbourne as well, which means it also holds true nationally – there are more charts showing that further on in the thread I linked to above.

        Outside Sydney and Melbourne, the rest of the cities have very low auction numbers as a percentage of total sales. There was a thread with the details on APF a while ago (number of auctions as proportion of total sales), I’ll see if I can dig it out. Melbourne has the highest proportion, then Sydney, and the rest are well behind.



  7. I would also argue the internet has made the leasing of rental stock more efficient. To a tenant, all available rental stock and pricing is only a mouse click away. To borrow a term Lord Ol Joye Its a “structural downward shift” in rental vacancy rate.

  8. Leith – if the comments above are any guide, it would appear current residential rental vacancy rates are nowhere near as low, as the usual sources of this information suggest.

    I am sure looking forward to more comments from prospective renters in Sydney im particular.

    As housiong bubbles inflate, generating general inflation and squeezing disposable incomes (Sydney being a classic example), people will do whatever it takes to lower their accommodation costs.

    California was another case, where there was a shortage of stock as the bubble inflated, but following the crash, enormous volumes of vacant housing suddenly appeared.

    I covered this within an article a couple of years ago “Housing Bubbles: Jumbo Mortgages = Jumbo Problems”, where, according to the hyperlinked Federal Reserve figures, when adjusted for population, there are actually a million less houses in the bubble market California than there should be, in comparison with Texas, which didnt experience a bubble.

    Bubble markets, such as those in New Zealand and Australia are inherently chaotic.

  9. Throw in the 122,000 unoccupied houses in Sydney. How many of these owners will become reluctant landlords?

    In Sydney, I’m sure there will be a lot of kids moving back in with their parents as they won’t be able to keep up with the running costs of owning their own property. A lot of parents encouraged their kids to take on large debts which they are now struggling to pay off.

    Retirees who factored in the value of their house for their retirement will find themselves having to sell and rejoin the workforce. Sadly there won’t be any jobs due to the negative effects of FTA’s and reduced tariffs on our manufacturing jobs. These people may have to move back in with their children.

    I also see the potential for Australian property owners to do as is done in the UK and have lodgers living with them. Make use of that spare bedroom to help with the ridiculously high living expenses.

    These 3 scenarios will increase household occupancy rates and rental vacancies.

    Any thoughts on lodging in Australia?

    • re: lodging, i’m assuming you mean sharing?

      I’got some Share Accommodation stats that I have been collecting for around 8 months that I will try to release in the next update of BurbWatch…

      See if that helps shed light on the picture, somewhat…

    • …Or, again check BurbWatch for over 9 months of such reductions trends! One for Australia and every state there! 😉

      Includes a sales and rental reduction instances density/pressure index too!

      /self plug end!! 😀

  10. Shadow & Leith

    My intuition is that liquidity (auction clearance)collapses when prices fall

    That’s what happens in the stock market or in Bank mortgage paper al la 2008

    Said another way… All the asset owners get to ride the correction (bubble) to the bottom.

    • Yep. I’m pretty sure this is what happened in Ireland. You get a kind of reversal of the rising market mentality. As an owner, you are too slow to accept the clearing price of the moment, which is heading ever downward. By the time you’ve resigned yourself to the (even paper) loss you have to take in order to have a chance of shifting the property, the market has moved away from you and it’s too hard to swallow, yet again. Meanwhile, most prospective buyers are sitting on the sidelines, waiting for some kind of floor to appear so it’s really hard to even find somebody who will *look* at your place. So you get the place tenanted and watch the rents slide due to the glut of rental accommodation that suddenly becomes available.

      • aka Deflationary Mindset 🙂

        So, after prices have been rising, largely because price have been rising; prices now fall because they have been falling…

        Hence, why mechanically-based econos keep getting these things wrong again and again….

        My 2c

  11. Is there anywhere else in the world that the Real Estate agents control the rental market AND the buy/sell market like Australia? I have lived all over the world, but never seen such an unregulated link between the rental and sales markets. It must have some obvious negative effects for consumers, and plenty of benefits to the rental agents.

    • It certainly does have effects. With almost all property controlled by agents it got so hard to find a place to rent in Sydney where we could keep our dog that it became a choice between, move countries, put down the dog, or buy.
      We reluctantly chose to buy. Of course our house is now going to lose value, a lot of value. But the price is only important when I got to sell it, and right now I like having somewhere to live. Will just have to take the large loss we do move.

    • Fundamentally its due to all the absentee landlords that require property management.

      Where the definition of property management means to spend as little on the upkeep as possible.

      I’ve lived in $700,000-$800,000 apartments and seriously questioned how the landlord is making a decent return based on the monthly rental.

      Of course even if I had the money to buy the apartment outright I would not do so. They date so quickly, why pay $800k for a 15yr old apartment, when you can maybe get a brand new one for $1 million?

  12. To add a trans-Pacific datum to your conjecture, rents in Vancouver Canada are stagnant. Core (purpose-built) apartment vacancy rates are close to 2 stdevs above the long-term average and have been at least 1 stdev above the long-term average since 2008. The non-core market is weak too, with vacancy rates likely above 5%. Rental rates have barely edged higher, I think about 1.2% above last year’s levels. Adding to the pain there was a net outflow of residents due to the government changing the ability of certain job classes to hire temporary workers. It may be worth a quick look to see if the same is happening in Australia, as it could affect the rental market quickly, since most temps rent.

    Owners who cannot sell due to sales market weakness pull their listings in frustration and rent them out. Yup. A weakened economy means people need to compromise on their accommodations to make ends meet. Absolutely.

    Another point is that if the home ownership rate has increased it means the available rental pool quality has decreased. This means when an increased supply does enter the market, there are slim pickings to fill those spots, which reduces net operating income due both to vacancy rates and increased overhead managing marginal tenants.

    I think, though, this is indicative of more: there is a liquidity squeeze, where leveraged and asset-rich homeowners need to continue to cash flow to cover margins. When the sales and refi market don’t cooperate the rental market is the last best hope for maintaining solvency. When the rental market fails them, where then will they go? (In Australia it may literally mean into the mines! LOL)

  13. Matches with my experience. Just rented here again in Wa and went about trying to find a private rental to get a longer tenancy – guess what – all the friends of friends were sitting on houses they wanted to sell but were waiting for the market to come back. They also had unrealistic expectations of price because some agent had been around and mentioned they “may” be able to get $500 a week just to get them to sign up. .

    One agent mentioned that supply is tightening up because some of her clients had sold up and were now entering the rental market and waiting to buy back in at a lower price.

  14. Hmm, something to consider- am about to start looking again and have noticed some interesting trends
    1. “renovations” new ones. I think some RE agents are telling owners of older places to slap up some paint to charge higher prices. I noticed because one place I looked at was on the market for $370 (and wasn’t an option). It was then pushed up to $450/week on the premise it was undergoing renos. back on the market strangely failed to attract renters, and has now dropped the asking price.
    2. Investors moving in- all of the “sold” signs I have seen lately have produced for rent signs next to them- the only people buying are the investors.
    3. Family homes on the rental market- there are quite a few properties that don’t look like the typical rental.

    There seem to be a few places that jumped in, trying to capitalise on the “flood” market of displaced owners and renters, but since they came into the market in april and may, not much to take advantage of.

  15. Is there NO effect from expectations of capital gains on the part of crazed “property investors”? Who cares about tenants when you’re going to get 10% per annum on your investment anyway?

  16. I am noticing a similar trend that others have mentioned in the very popualar inner east area of Melbounrne. Friends of mine, whose lease is due to expire in July, were planning their imminent move as they had had continual fights with their landlord, and they were sure the landlord would want them out. Anyway, agent asked them the other day if they would sign another 1 year lease! Enquired further of the agent (who they get along well with), and turns out she had had 3 inspections that day for 3 different 2 bdrm houses (this is Prahran), and only 6 couples in total turned up.

    I am also noticing many more For Lease boards around the area. Particularly on blocks of flats where a year ago they wouldn’t have even bothered with a board, the internet lisitng and strong demand would save them the cost of the board.