What will happen to vacancy rates with unemployment rising?
The International Monetary Fund (IMF) recently issued a revised economic outlook in response to the COVID-19 health crisis and its growing impact upon the global economy (14th April 2020).
In the article, the IMF forecast global growth to fall to -3%, representing a downgrade of 6.3% points from January 2020.
According to the IMF:
“This makes the Great Lockdown the worst recession since the Great Depression, and far worse than the Global Financial Crisis”.
Is this statement cause for concern, or is it merely fear-mongering on a mass scale?
It's undeniable that the COVID-19 pandemic has ended the longest period of sustained economic growth seen in Australia.
Before the pandemic, we enjoyed an extended period of stable, albeit, moderate growth; low inflation, and low financial market volatility.
More recently, economic growth has been underpinned by low risk-free interest rates and an economic environment that did not present with any significant indicators of downside risk which were present before and during the GFC.
As noted by the Reserve Bank of Australia in the most recent Financial Stability Review for April 2020 [2]:
“The outbreak of the virus, which was not even a feature in the outlook at the start of the year, has changed this. The exceptional measures taken to contain COVID-19 are having a major effect on economic activity and the global financial system”.
The high level of uncertainty surrounding the size and duration of the economic downturn is accentuated by the uncertainty around the effectiveness of the various measures in containing the spread of the virus.
Due to the uncertainty surrounding the containment and management of the health crisis, it remains to be seen how long it will take to return to some semblance of normality.
What does this mean for unemployment?
It's anticipated that the unemployment rate will continue to escalate until efforts to “flatten the curve” and allow for the resumption of trade/employment of non-essential jobs can commence.
This view is supported by recent comments made by the NAB [3].
“With the fall in GDP quite extreme, unemployment could normally be expected to rise further. However, we expect that the “job keeper” package will help to contain unemployment at around 11¾% by mid-year with little improvement in the back half of 2020.
With a weaker growth profile and the expiry of some fiscal packages we would now see unemployment still at around 7½% by end-2021 (previously around 7%).”
What does rising unemployment rates mean for property investors?
Property investors who are more highly leveraged could struggle if tenants are unable to pay rent.
Most households had sizeable cash and/or equity buffers going into the economic downturn. Additionally, many affected workers will have access to wage subsidies and superannuation balances to compensate for lost income.
Plus, many of the major lenders are offering repayment deferment.
According to the RBA Financial Stability Review, these factors will help households manage their debts during this difficult period. However, other households are not as well placed to withstand the downturn.
As it stands, a vast number of the workforce have been stood down or have had their employment terminated. With the crisis expected to continue for the short term, it's anticipated that the number of persons that fall into these categories will continue to grow.
RBA indicates that most households entered this difficult period in good financial health with most households having enough liquid assets to cover basic living expenses and current obligations, such as mortgage and rent payments, for three months.
Among these borrowers, over half of these loans had enough prepayments to service their loan repayments for at least three months as reflected in the graph below.
Vacancy rates
Data released by SQM Research on 14th April 2020 has revealed the national residential rental vacancy rate has remained stable in March 2020 at 2.0% since last month, with the total number of vacancies Australia-wide now at 67,371 vacant residential properties [4].
Most states recorded minor declines in vacancy rates with except Sydney, Melbourne and Darwin which were stable.
The outlook
According to Managing Director of SQM Research, Louis Christopher:
"The minor decline in most capital cities’ vacancy rates for March was somewhat surprising given the uncertainty around the economy. With job losses, a freeze in migration and an expected sharp rise in short-term accommodation vacancies, we are likely to record significant increases in rental vacancy rates as 2020 progresses.”
If unemployment continues to rise, this will place pressure on prospective tenants’ ability to pay, therefore placing downward pressure on rents in the short term.
Capital city asking rents decreased 3.2% for houses and 2.9% for units for the week ending 12 April 2020 to record asking rents of $544 per week for houses and $428 per
week for units [4].
With employment conditions weakening, property managers indicate that tenants are choosing to remain in current leases and negotiate more favourable terms in the event of economic hardship.
For properties that remain vacant, we will likely see a softening in asking rents as the unemployment rate rises and landlords begin to discount rents to reduce vacancy periods.
This trend will be more pronounced in markets with a stronger proportion of renters vs owner-occupiers.
Onwards and upwards
On the bright side, Australia is proving to be a world leader in terms of its response to managing the infections/ transmission rate and “flattening the curve".
Should this trend continue, it's likely that the current isolation measures will be relaxed, allowing for a quicker resumption of trade and the commencement of the recovery in employment and economic growth.
The well-targeted economic stimulus from policy makers will support demand, job growth that will aid the recovery.
If this scenario transpires, it is anticipated that as economic conditions improve, vacancy rates will improve and therefore, place upward pressure on asking rents.
Bradley Wearne - General Manager & Head of Research at Meridian Australia
P: (02) 9939 3249
References
[2] RBA - Financial Stability Report
[3] NAB - April Forward View
[4] SQM Research