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Capital Economics: Lower Rental Yields Undermining Investment Case

Lower rental yields in today's market may threaten to drive out investor interest, but ""Capital Economics"":https://www.capitaleconomics.com/ sees no reason to start worrying just yet.


In its latest US Housing Market Update, the analytics firm addresses the uneven gains seen between home purchase prices and rent costs over the last year. (The report cites January data from CoreLogic, which shows prices rising 9.8 percent year-over-year with rents rising only 2.7 percent in the same period.)

The disparity is weighing on rental yields. By Capital Economics' measure, average gross rental yields--annual rent payable on a property divided by its current value--fell from a peak of 5.5 percent in early 2012 to 5.31 percent by the fourth quarter.

""In a US Housing Market Focus from last year we highlighted that the house price gains that investor interest in housing are driving would eventually price many of those selfsame investors out of the market,"" writes Paul Diggle, property economist for the company. ""The mechanism will be via a reduction in rental yields and less potential for capital appreciation, to a level that doesn't compensate investors for the high set-up and management costs of residential investment.""

For a housing market still reliant on investor purchases, the phase-out may represent a serious problem.

Diggle offers as evidence the case of Phoenix, Arizona, a hard-hit market that has largely been revived as a result of investor activity. There, prices have risen by 23 percent over the past year, rendering the city a ""no-go area"" for many institutional investors interested in cheaper prospects.

However, Diggle notes lower yields are unlikely to dampen investor interest in housing, at least in the short term.

""First, the decline in rental yields is still very gradual and will see yields remain high relative to Treasuries for a while yet. While we expect the 10-year Treasury yield to end the year below 2 percent, our forecasts for house prices and rents imply gross rental yields averaging 5.1 percent during 2013.

""Second, even as the typical rental yield slides backwards, our expectations for an 8 percent gain in house prices this year implies a healthy total return for investors. Indeed, at 12.7 percent in Q4 2012, the total return from housing--rental yield plus capital appreciation--was already at its highest level since early-2006,"" he writes.

For the time being, at least, Capital Economics expects investor demand to continue to act as a major support for the recovery. However, with fewer distressed assets for sale and price gains leaving less potential for capital appreciation, that increased interest has an expiration date.

""In that context, the 14 percent increase in mortgage applications for home purchases over the past year has been an encouraging sign that mortgage-dependent buyers may be beginning to play more of a role in the housing comeback,"" Diggle remarks. ""But there's no doubt that demand from this group will have to strengthen by a lot more to keep the recovery going.""


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