How do vacancy rates affect rental yields?

Vacancy rates give an indication of the percentage of rental properties that are vacant within a market. In general terms, the higher the percentage of vacant properties, the weaker the level of demand present in the local market.

Typically, a vacancy rate around 3% is considered equilibrium (a balanced healthy market). Anything above equilibrium reflects a market in oversupply. This favours tenants as there are more homes to choose from. Below 3% indicates undersupply. This favours landlords, as there are more tenants to choose from.

Rental yields and vacancy rates are two common indicators which have a close relationship.

A perfectly good example of this relationship is the performance of the Sunshine Coast. Currently, SQM Research data indicates the region is experiencing record low vacancy rates of 0.6% and record-high rental yields for apartments of 5.2%.

As you can see from the above graph, when rental yields increase, vacancy rates tend to decline—identifying an undersupply in that market.

What else can vacancy rates and rental yields measure?

Well, rental yields don’t just measure your cash flow and income from your tenant. Gross rental yield is gross annual rent divided by house price. This means rental yields are also influenced by price growth. On the other hand, a suburb with a low vacancy rate means there is demand in the area but a shortage or lack of supply.

If there is demand from the rental market, it is safe to assume it is a desirable area to live. Desirable areas attract home buyers and renters alike. This is why owner occupier appeal is one of the key fundamentals when looking for an investment property.

If a location becomes attractive to live in, tenants will move there before homeowners. This is due to their mobility and ease of getting into the market. They will put downward pressure on the vacancy rate, making the location appealing to an investor to buy there. If home buying and demand in an area increase, what typically follows is capital growth.

To illustrate the above point, we can again consider the Sunshine Coast. In April 2020, the Sunshine Coast region’s vacancy rate was 2.4%. By July 2020, it had dropped to 0.7%. It continued to fall to its November 2020 trough, then stabilised around 0.5% where it remains. When it comes to homes for sale, however, the sharpest drop in lengthy stock on market was a few months later around spring-summer 2020. This is indicative of growth in buyer activity.

Vacancy rates are an important factor to take into account before you invest. To put it in a nutshell, you should be looking for markets with low vacancy rates in order to capture markets with the strongest rental demand. Ultimately, selecting markets under pressure from tenant and owner occupiers alike, will allow you to hold quality assets for the long term.

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