The Sydney property shortage

The Sydney Morning Herald today repeats the claim by the real estate industry that Sydney rents are about to soar. It's interesting the forces behind this claim. I can't help but think this is a self serving beat up by the real estate agents in the run up to the state election.

Sydney's problem is simply that property, in relation to income, is way overpriced. This is a combination of Sydney's geographic and economic advantages, Australian's historical preference to invest in property and an income tax system that favours property (and other passive) investments. To make matters worse, we have interest rates at the lowest in a generation and a Federal government that happily ramps the property market for it's short term gains.

The result of these factors is that the cost to buy is outrageous. It also means that more and more Sydneysiders can only afford to rent. As the demand side of rents is a function of wages, rents have stayed comparatively low as wages haven't grown the same way property prices have.

Fifteen years ago, the rule of thumb for Sydney rents was to knock three zeros off the market value to get the weekly rent. That 5% yield is now less than 3 and dropping fast. Compared to other investments, that's a lousy return and super now has better tax advantages.

I suspect the real estate agents are trying to encourage landlords to stay in the market with the promise of better returns. The problem is a 20% increase would still only leave yields around the 3% mark. Their other motive is to panic the state government into releasing more land and easing zoning rules.

But let's say the agents and their pet economists are right. A 20% hike in rents will be a disaster for Sydney. We'll either the Sydney economy go into a nose dive, or see inflation break out.

As an employer, I already have serious trouble finding techs who live East of Strathfield. Put another 20% on their costs and I'm going to have to pay more to cover either their higher cost of living or their increased travelling costs. A spike in inflation means higher interest rates.

The alternative is my view more likely; a 20% increase in rents will kill the Sydney economy stone dead. In many inner suburbs more than 50% of the residents are renters. Take a fifth of their after tax income away and suddenly they can't afford lattes, plasmas or nice cars.

Either scenario means the same thing: Sydney property prices drop. Sydney's real estate agents and their tame economists should be careful what they wish for.