What drives rents up?

I had this conversation at dinner a few nights back. I held the minority view and argued why a landlord’s increased costs aren’t an immediate trigger for putting rents up.

“You can’t just put the rent up because your land tax bill is higher. It doesn’t work that way.”

From increased mortgage rates to taxes, heightened insurance premiums to special levies, many landlords falsely assume that they can directly pass their costs on to their tenant when surprise bills strike.

The simple fact is that weekly rents, particularly when initially set and advertised, are a product of supply and demand.

If a tenant feels that an asking rent is disproportionate to the going rate, they will vote with their feet and take on the lease that represents better market value.

Increased costs can stem from many sources. But when the bill arises from a property- specific issue, (as opposed to a widespread and mainstream issue such as an interest rate movement) the landlord will struggle to justify their proposed rent increase and could face a nasty vacancy. It may come as a surprise, but I’ve fielded rent-increase questions from landlords who have incurred costs for invisible repairs. One had an expensive roof repair bill and thought it was acceptable to increase the tenant’s rent on the basis that he’d had an unexpected expense.

“It doesn’t work like that”, I had to explain.

He seemed perturbed that in order to justify a rental increase, he had to demonstrate that the rental market had in fact moved, or alternatively he needed to appeal to a higher price bracket of renters by offering more impressive features to the property.

The laws of supply and demand would see this investor’s property languish on the rental market if he was to try to subsidise his own expenses via a rental increase.

Putting aside this simplified economic statement, there are anomalies that landlords need to be mindful of, and while a market driver won’t necessarily instantaneously trigger a rental increase, the longer-term effect of a widespread and mainstream cost-increase will ultimately put pressure on rents to increase.

Take increased interest rates as an example. Most landlords will be sensitive to the changed conditions of their cashflow scenario and could seek to put the rental up at the next opportunity. Provided the majority of landlords do so in a similar fashion, rents will likely move up. However, if landlords don’t move their rents in sync (and they won’t, as lease expirations all vary), there will be notable delay. This lag effect is normal in our market and it almost always takes a few months to a year to wash through. The landlord demographic also plays a key role. The following categories of landlords could leave the rent in place for any of these reasons:

• A landlord who is not cashflow-sensitive and is not aware of the local market conditions may not realise that market conditions enable a rent increase. It would be fair to suggest that their property manager is not doing a good job if this reason applied.
• A landlord who does not hold a mortgage will not be burdened by interest rate movements and the adverse impact on their cashflow
• A landlord who appreciates their tenant and fears the tenant leaving if a rental increase is applied
• A landlord who is acutely aware that their market demand from tenants is low, (ie a country town with limited population numbers)
• A landlord who owns property in a high vacancy-rate area (with landlords who are willing to compete with rent-discounting to secure a tenant)
• An apathetic landlord who couldn’t be bothered with the paperwork and/or tenant communication (it does happen!)

Likewise, on the flip side of the coin, there are tenants who will face a rental increase letter and vehemently oppose the unfair increase.

They will simply give notice and vacate.

But those tenants who don’t take this course of action in the face of an unfair rental increase may choose to tolerate it for any of the following reasons:

• Apathy (again, some people are lazy)
• Genuine fear/concern about moving (ie. packing, re-establishing a neighbourhood)
• Limited alternative options during the off-peak rental season (we do genuinely experience a slowdown in rental demand in our cooler capitals during winter, and in our ‘work contract’ cities when new contracts are slow; typically winter)
• A knowledge that their personal situation will lead to challenges with finding a replacement home (ie. pets, poor payment history, unique needs for a specific style property)
• Family/friends/work/school close by (cost/benefit equation is still valuable to them based on the proximity of important people/things)
• Limited market pricing awareness (they just assume the increase must be commensurate with market values)

In our current rental markets, particularly in our two capital cities, landlords are experiencing change as we speak. The combination of lending constraints increased lending scrutiny, the threat of negative gearing changes and the sheer increase in new arrivals is putting upward pressure on many rents. Being cognisant of the drivers is vital, and staying on top of market pricing is a sensible action that all landlords should take.

But assuming that rents should just “go up” each year is naïve. A market force has to enable this, or the resultant scenario could be a bitter tenant, or worse still, one who vacates, only to leave the property on the rental market for weeks or months.

Rental is driven by supply and demand, but anomalies do throw out some curve-balls.