Have higher rents covered landlords' higher costs?

As rents rise to sky-high levels there's an assumption that landlords are cashing in on the crisis but with higher interest rates and expenses is that the reality? Our case study offers a strong hint.

Renovated cottage home in Melbourne.
This renovated property in Melbourne has gone from cash flow positive to significantly cash flow negative in four years. (Image source: Cate Bakos)

While soaring rents across our capital cities and regions are well known, less has been said of the heightened costs associated with holding an investment property.

Rents have broadly changed by approximately 10 per cent per year since early 2020 for most capital cities. Darwin, Canberra and Hobart have exhibited lower rental growth, however, these markets capture considerably fewer investors.

A raft of increased expenses have been imposed upon landlords, including land tax, council rates, water rates, maintenance costs, insurances and property management fees. But the largest cost increase by a hefty magnitude is interest.

Over the past two years, investors have experienced a sharp incline in costs and, for many, the negative cash flow associated with holding an investment property has forced them to either sell or consider selling.

The burning question is: Have rental increases covered these additional costs, or are investors feeling the pinch more now than two years ago?

Land tax, council rates and water rates all vary from property to property and across the different states and territories.

Some states that have experienced a change in land tax thresholds, (such as Victoria with the “Covid Temporary Land Tax”), and many of these costs have moved significantly of late.

In addition, as capital values grow and state governments re-evaluate capital values, many investors will find themselves eligible to pay higher land tax. Likewise, as local councils reapply valuations, council rates will increase to reflect the higher unimproved values of properties within their jurisdiction.

Many could argue that maintenance costs are relatively consistent, however, legislative changes to minimum rental standards, combined with the introduction to mandated compliance checks, (such as electricity and gas) have increased the average maintenance surcharges for investors.

Another increased cost to investors is the property management fee. The vast majority of property management firms charge a percentage fee of the total rent collected.

The cost per property managed has increased in line with the rate of rental increase. For example, a 7 per cent management fee on a $500 per week rental property equates to $35 per week. For those properties that have experienced rental increases of 20 per cent over the past two years, rent of $500 per week would have increased to $600 per week, and accordingly, the landlord would be paying $42 per week to the same property manager.

Directly relating to both inflationary pressures and environmental conditions, we also have to consider the cost of insurance. Property related insurance premiums have increased by around 20 per cent since early 2020.

But the most significant increase has been mortgage repayments. Whether investors have adopted principal and interest loans, or interest only loans, their interest costs have been amplified.

The average investor loan in Australia is $619,000.

From March 2020 to May 2022, the variable rate for a standard loan product generally sat under 3 per cent, and for many customers, sub-2 per cent. Plenty of investors fixed their loans during this time at lucrative rates.

An average loan size customer would have been paying $12,380 per year on a 2 per cent, interest only loan, over a 30-year loan term, or $27,455 on a 2 per cent, principal and interest loan.

In today’s lending environment, the same investor would be paying interest on a 6 per cent-6.5 per cent interest loan, depending on the lender.

Let’s assume a figure in the middle of this band; 6.25 per cent. On a principal and interest loan, the investor’s annual mortgage repayments would be $46,950, and on an interest only loan, $38,687,50.

The visuals below show the difference between the pre-2020 mortgage rates vs rental income and the 2024 equivalent.

I have assumed 20 per cent rental increases for the average investor. Other assumptions include the following; an average rental of $600 per week in today’s climate versus an average rental of $495 per week. The annualised figure for both is $31,200 and $25,740, respectively.

A case study of rising costs

Rental income: $25,740
Minus interest repayments: $27,455
  • Land tax
  • Council and water rates
  • Insurance
  • Property management
  • Maintenance
Rental income: $31,200
Minus interest repayments: $38,687.50
  • Land tax (up noticeably in some states)
  • Council and water rates
  • Insurance (up ~20%)
  • Property management (up ~20%)
  • Maintenance (higher now with new rules)

Even when we factor in the costs associated with the earlier list of outgoings; land tax, council rates, water rates, insurances, management fees, and maintenance costs, the investor’s out of pocket cost is far greater in today’s climate than what it was four years ago.

One thing that investors can positively factor in is reduced vacancy. These days, the current rental demand has tightened the periods of no rent. And if we cast our memories back to 2020 and 2021, some cities, (particularly Melbourne) were hard hit with vacancies. The State Government introduced an eviction moratorium, and many landlords were faced with lower (or zero) rents during this time.

Case study of example investment property in Spotswood, Melbourne

Purchase price: $540,000

Stamp duty: $27,470

Renovation loan size: $200,000

Total finance borrowed: $767,470

Expenses 2020 2024
Interest $15,349 $47,967
Council Rates $1,696 $1,708
Insurance $773 $1,080
Land Tax $1,225 $2781
Property management $1,716 $2,008
Maintenance ~$1,000 $1,500
Rental income $26,000* (we later offered a COVID discount 20-21) $30,420
Net cashflow: Cashflow positive: $5,141 Cashflow negative: $26,624

There is little doubt that the net cost of investing in property has risen in recent years for investors.

Obviously, investors do so for a reason though. Capital growth is their rationale, and like other asset classes, time in the market rewards investors over the long term. Most investors who have held property for decades would presumably be enjoying cashflow positive outcomes now.

Continue Reading Property Management ArticlesView all property management articles