Rents: What we think will happen and why

The demise of Airbnb plus double-digit unemployment will lead to an inevitable drop in rents. The question is, how much by?

Firstly, before I start this piece, I want to praise the New Zealand government for how they have acted during this worldwide crisis. The world is looking at New Zealand in admiration which also sends a beacon of hope to other nations struggling to deal with this pandemic. Prime Minister Jacinda Ardern and her team have done a remarkable job in acting decisively, making tough decisions quickly which has probably led to thousands of lives being saved. Simon Bridges must also be praised for not playing party politics and assisting through heading the select committee. Yes, we are not out of the woods yet, by any stretch of the imagination. However, we have seen the necessary steps taken to restrict and hopefully even eliminate COVID-19 from our shores.

There is, however, an enormous price to pay for the decisions that have been taken to protect us from this hideous virus. Thousands of hard-working Kiwi’s will lose their livelihoods through absolutely no fault of their own. Many businesses both large and small have or will go insolvent. We will also see mass layoffs across the country and our once buoyant Tourism sector has been absolutely decimated. This is no criticism of the Government, what was the alternative? Let the virus run amok and watch thousands of Kiwi’s die along with our health service crippled? No thank you. The economy will recover though it will take years to do so. The alternative was not worth contemplating and a lockdown was inevitable at some point in time.

As the initial shock has passed and we get used to being in our own ‘bubbles’, thoughts begin to look at what the long term fall out will be when the dust finally settles from this crisis. The question our industry is probably asking the most at the moment is what is going to happen with rents both in terms of defaults and price? 

Government response appropriate 

In my opinion, the Government was largely right in it’s the initial response to protecting tenants with the introduction of COVID-19 Emergency Response Legislation Bill. We all know the content of this Bill by now as we have had to deal and work through numerous scenarios as we entered the Level 4 lockdown period. Tenant’s needed to be protected however it is debatable that allowing tenants the right to move was the right thing to do. It seems unnecessary to allow tenants to move unless there were certain circumstances such as the threat of domestic violence. Overall though, the Government has done a good job in the most challenging of circumstances. 

Yes, some landlords have been left exposed and are now sat there with empty properties and no rent, even though they may have had a tenant due to move in. In other cases, landlords have had to make alternative arrangements as they were due to move back into a property which was being used as a rental. I genuinely feel for people in these scenarios, yet the reality of the situation means that there are always going to be victims.

We are now hopefully over the halfway point of the lockdown period and it has been nearly a month since the borders were closed to non-New Zealand residents. As such, we are already starting to see the initial impact in terms of what could potentially happen with the rental market in New Zealand. 

Survey highlights concerns of companies

We have introduced a fortnightly survey during the crisis in an attempt to gauge what will happen with rents both in terms of defaults and price. Different companies in different regions have differing opinions. The initial response is that companies in regions with higher rents are more likely to see a greater fall as a percentage and have a higher default rate. Property Management companies in Auckland and Wellington are predicting default rates in excess of 20%. This is concerning and if they are correct, 1 in 5 tenancies will fall into arrears. 

REVIEW WEEK 1 RENT DEFAULT SURVEY

After the first week of the lockdown, companies who completed the survey highlighted a rise in arrears from 3.23% at the beginning of the crisis to 6.57%. This is inevitably going to rise and some areas, such as Queenstown, are going to be hit far worse than others.

The concerns highlighted in this survey indicate how important it is to have an open and constructive dialogue with both tenants and landlords alike. The traditional methods of a zero tolerance to rent arrears approach can no longer apply. There is an enormous amount of emotion, fear and stress involved in the current climate. Tenants and landlords will both be feeling the pain and strain financially as well as emotionally. Unfortunately, there will also be people taking advantage of the situation claiming hardship when they are not distressed or simply refusing to pay rent without dialogue with their Property Manager. What can you do in these situations now that applying for termination is no longer possible unless the tenant is 60 days or more in arrears? It is not an easy answer.

Take our second COVID-19 Rent Default Survey

Getting the balance right between protecting landlords and tenants whilst following the letter of the law and fully respecting each individual case generated by the situation can be extremely precarious. As many Property Managers are finding out, this must be done on a case by case scenario and delicately so.

Falling rents are inevitable. The question is by how much?

Opinions about how much rents will fall, if indeed they will fall, seem to be split not just within our survey, but by influential market commenters. 

Over 40% of offices surveyed believe rents will hold. The rest seem split as to how much they will fall by. No one believes we will see rents fall by greater than 20%. Industry commenters such as Ashley Church of Oneroof believe that rents will hold in the long term due to a lack of supply whilst others such as Economist Tony Alexander believe that there will be a drop in rents and landlords need to be ready for this.

I am of the opinion that rents will inevitably drop and at a guess using more gut feeling than analysing any data, I believe that nationwide we could see a drop by as much as 10%. There will be variances in different locations. For example, Queenstown may see a 20% drop whilst some lower-income towns such as Whanganui, Invercargill or Levin may hardly see a change due to the relatively low rents that these towns demand. 

Likewise in the main centres, different suburbs may see differing scenarios. High-end rental suburbs may see a bigger hit as employers lay off staff or freelance workers find that their inflow of work dries up. However, suburbs such as Mangere or Manurewa in South Auckland and Stokes Valley in the Hutt Valley will likely fare better. The apartment market in Auckland will be hit hard in the absence of overseas students.

What I have come to learn from the years that I have spent working in this industry is that rent is primarily dictated by the two things. Peoples income and supply v demand. If rents exceed more than 40% of the tenant’s net income, then they will likely struggle with payments. Incomes are going to decrease and rents will follow suit. There are other factors that will also contribute to falling rents.

Airbnb set to flood the market

It is hard to find positives in these hard times however one potential positive is the demise of Airbnb leading to a much needed increase of supply of long term rental property. I have long been of the opinion that Airbnb has contributed very little to society and the negatives around it far outweigh the positives. Many landlords have made decisions to seek better returns and avoid the compliance enforced on them by Government policy such as Healthy Homes. This has led to a surge in what would typically be long term rental properties moving to the short term market. Just when we saw a massive need for rental accommodation, a shortage is created partly through landlords opting for Airbnb instead. This has helped fuel the rental shortage with a record number of tenants seeking accommodation supplements and emergency housing.

Once we come out of the lockdown, it will be fascinating to compare how many rental properties are available on platforms such as Trade Me compared to the same period last year. The short term market has been handed, in the short to medium term at least, a near fatal blow. 

All you have to do is look at places like Queenstown and Wanaka to get a glimpse of what is coming. As the borders were closed and bookings cancelled, many Airbnb hosts scrambled to get their properties onto the market before the lockdown took place. Expect to see a lot of ex-Airbnb properties available to rent very soon.

No wage growth and high unemployment adds to pressure on rents

Who knows how bad unemployment will get in the coming months. Some are predicting double-digit unemployment with the outcome of this meaning there will be a huge supply of talent looking for work and this will put downward pressure on wages. I used to argue that Property Management had real issues in retaining talent due to the high pressure that the job entailed. I no longer see that as being a problem. 

The net income for New Zealanders will be negatively impacted and this, in turn with an increased supply of rental property will lead to an inevitable drop in rents.

There are other factors that we need to take into consideration as well. Net migration and a lack of oversea’s students will lead to a drop in demand in student accommodation and younger renters may actually move back in with their parents to save money if they find that they have lost their source of income. In the long term, I would not be surprised to see some commercial office space convert to residential as well as many people will continue to work from home post-pandemic as well as many commercial tenants will go to the wall leading to a glut of commercial property being available.

Places like Christchurch will fare better as rents are already more affordable in the Garden City compared to other highly populated regions such as Auckland and Wellington however overall, most, if not all regions will see a significant drop in rents.

Will landlords sell on mass or will they hold?

It has been suggested that many landlords will sell on mass, but realistically I think this is highly unlikely. Although many Property Management companies will see revenues drop due to decreasing rents, I believe that this will be offset through a decrease in the natural churn rate of lost managements. Typically, we see a fair percentage of churn when landlords leave due to many of them selling. If a rent roll of 500 loses 100 properties a year, roughly 30% of these are likely to be sold. 

However, my belief is that the only sales we will see are landlords in distress as they are forced to release capital or through mortgagee sales. A drop in sales will be good news for Property Management businesses but potentially bad news for real estate teams. It is very hard to predict what will happen in terms of volume of sales and house prices. I suspect that many vendors will go into a holding pattern, waiting to see what the fallout of the crisis will be. In one of his recent releases, the brilliant economist Tony Alexander has commented how hard it is to predict what will happen to the volume of sales but he is estimating that there could be as much as a 40% drop in property transactions.

People will be very nervous making any sort of capital investment unless they are getting it at a perceived bargain price. The unpredictability of the entire situation will leave many potential vendors waiting on the sideline as they assess what is happening on the field of play. Some vendors may even turn to renting out a property that they would have typically sold if the property market dips, similar to what happened in 2008 post-GFC.

There will also be opportunity. I’ve got no doubt that there will be many landlords who will have plenty of equity with minimal debt who will be waiting for the lockdown to end. Add record low interest rates into the mix and many cashed up investors will be looking to re-enter the market. However, I do not expect them to go into a market prepared to pay prices pre-crisis. What I think will happen is that we will see a classic ‘Mexican standoff’ between vendors and purchasers with the only sales that we will see are vendors who are forced into selling.

I conclude with a word of warning to Property Management businesses up and down the country. All businesses will look to tighten their belts and assess where they can cut costs. Landlords are no different. Some will be looking at the Property Management fee as a potential saving as many may turn to DIY self-management. Make sure that you are servicing your clients. They will need a professional Property Manager more than ever as we have to deal with any number of issues whilst the Healthy Homes standards and the proposed RTA Amendment bill are still lurking in the background and not going away. Make sure that you look after your consumers both landlord and tenant alike and of course, look after each other.

Good luck, stay home, save lives and let’s continue to flatten the curve.

David Faulkner