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The peak in interest rates could signal a drop in rents

As inflation is dropping, the Reserve Bank (RBNZ) has ended OCR rate hikes and this could signal a decline in rents, CoreLogic says.

By: Sally Lindsay

31 July 2023



Growth in rent values usually tracks roughly with movements in the cash rate. Not only has the OCR peaked, but most of the major banks are now forecasting a reduction in the cash rate and interest rates next year.

How are rents and interest rates related?

Rents and interest rates move together over time, so a peak in the cash rate may indicate that growth in rent values is also at (or near) a peak.

There are multiple reasons these two series might move together. For one, rents are an input in measuring inflation. When rents rise, inflation can rise, and this prompts the RBNZ to lift interest rates, the housing market forecaster says.

Secondly, interest rates can impact rent. Higher interest rates mean investment property becomes less attractive, which could slow the delivery of new rental stock coming to market, and this could push rents higher.

Other factors affecting investment activity can have an impact on the rental market.

For example, rental supply started dropping off in 2021 when the Government announced the phasing out of mortgage interest payments offset against rental income for tax deduction purposes. This was to deter investment in existing houses.

That, together with rising interest rates, led to investors sitting on the side lines and buying activity waned.

Have higher interest rates forced investors to increase rents?

Investors may have increased rents to help fund higher mortgage costs and offset the loss of tax deductibility, but it’s unlikely rents have been increased to the full extent of interest cost increases.

Valocity research shows there has been a sharp increase in the amount negatively-geared investors are having to top their properties.

The numbers have increased substantially, from $5000 on average a year in 2021 to $30,000 today, as a result of higher interest rates, an article in Stuff indicated. 

Valocity senior research analyst Wayne Shum said some owners were now reliant upon house prices rising 2.7% to 3% per year in order for the expense of holding the property to be worth it.

To put recent rate hikes in perspective, Trade Me’s monthly median rent asking prices have increased from $570 in May last year to $610 in May this year . However, mortgage costs of a new investment loan are estimated to have increased from $1,811 per month from May last year on the median New Zealand dwelling to $2,339 in May this year.

Trade Me expects to see rents taper off later in the year as landlords respond to stalling wages and tenants' lack of disposable income. It is already seeing the market impacted by changes to tax policies, and higher interest rates.

Investors who have no mortgage or a small mortgage may have also taken advantage of tight rental market conditions to increase the return on their investment properties.

Irrespective of mortgage costs, rents can generally only rise substantially if the rental market is competitive, and tenants cannot find alternative accommodation to bargain with; in other words, rents rise when demand for rental accommodation is outweighing supply.

It’s clear that the rental market was tightening well before interest rates started to rise. It tightened from a number of factors besides interest rates, including investor uncertainty.

Higher interest rates and the lack of tax deductibility slowed investment activity last year and is still continuing, but they haven’t been the sole cause of rental increases.

Rent growth is expected to slow in 2024 for a number of reasons:

  • As renting becomes less affordable, numbers will swell on Housing New Zealand’s waiting list, which will reduce rental demand.
  • Construction cost increases are easing, and fewer building consents means the construction space may also unwind next year. As the elevated pipeline of residential dwellings under construction are completed, renters who may have been waiting for new homes to be completed can exit the rental market.
  • Next year may see a lift in rental supply from government initiatives around social and community housing provision, and build-to-rent projects will gradually flow into the market.

Housing finance data shows investors are already returning to the housing market, and this bounce-back is likely to be stronger next year if interest rates decline and home values continue to rise.

RBNZ figures show the share of new lending to investors in May rose from 16.6% in April to 16.9% in May. However, compared to one year ago, the share to investors has fallen from 17.5% in May 2022.

While national rent values have never seen an annual decline, rent growth is likely to continue moderating as the supply dries up.

Trade Me figures show the supply, or the number of properties available to rent in May was down 19 per cent from May 2022, while demand was up 35 per cent.

There were a number of factors driving this including the collapse of tourism and migration during the pandemic, leading to investors pulling their short-term rentals, and putting those properties into the long-term rental market.

Now that has reversed. People are moving their properties back into the tourism market where they can make money with fewer obligations.

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