Human Services Victoria - Investment Returns Rental Housing

Investment returns from rental housing in Melbourne, 19982009
Department of Human Services Victoria
Investment returns from rental housing in Melbourne, 19982009

Department of Human Services Victoria
October 2010
iv Investment returns from rental housing in Melbourne, 19982009
Privacy notice
The research undertaken for this report uses unit record information with addresses to enable matching of sales and rental data. The research is to enable the Government to better understand the housing market so that it can monitor and design housing assistance policies to contribute to housing affordability in Victoria.
Disclaimer
This report is provided for public information only and no claim as to the accuracy of the results for future investment decisions is implied. The research represents only an eleven year period in Melbournes residential market. The Department of Human Services accepts no responsibility for any decisions regarding residential investment made as a result of reading thisreport.
Copyright
This publication is copyright, no part may be reproduced by any process except in accordance with the provisions of the Copyright Act 1968. Authorised by the Department of Human Services, 50 Lonsdale Street, Melbourne, Victoria 3000. This report may be downloaded at www.housing.vic.gov.au. For a report in a specific accessibility format please call +61390967715 or email housing@dhs.vic.gov.au.
Contents
Acknowledgements Executive summary Introduction Context
Residential investment in Melbourne, 19982009 Melbournes rental market, 19982009 Policy context
vi vii 1 3
3 7 11
Rates of return for Melbournes rental housing, 19982009

The method the internal rate of return The model RMIT IRR The sample matched sales and rentals
15
15 15 17
Analysis IRR for hypothetical rental investors Melbourne 19982009

Individual investors Company investors Superannuation fund Investors
18
18 20 21
Closing the rental gaps NRAS

A company investor with NRAS A superannuation fund investor with NRAS
23
24 24
Conclusion Some further considerations

Continuing the analysis
25
25
Appendices
Appendix 1: Constructing the sample Appendix 2: Structure of the IRR model Appendix 3: Capital gain and rental yield Appendix 4: Supplementary tables detailed IRR for each hypothetical investor
26
26 29 34 39
vi Investment returns from rental housing in Melbourne, 19982009
Acknowledgements
The Director of Housing and Executive Director, Housing and Community Building, Department of Human Services Victoria, acknowledges that this report has benefitted from the substantial contribution of Professors Mike Berry and Gavin Wood of the RMIT University Australian Housing and Urban Research Institute Centre (AHURI) Research Centre. Professors Berry and Wood provided the impetus for the project, and undertook the data preparation, modelling and drafting of the report. The work was undertaken with the aid of Ms Elizabeth Taylor, Dr Frank Harman, and Dr Christian Nygaard at the RMIT University AHURI Research Centre. For the data: Residential Tenancies Bond Authority (RTBA); Consumer Affairs Victoria Department of Planning and Community Development (DPCD) Department of Sustainability and Environment (DSE) The rental data are provided to the Director of Housing under Section 431 of the Residential Tenancies Act 1997 for the purposes of research, compiling statistics and public education. The sales data are provided by the Valuer-General under Section 5 of the Valuation of LandAct1960.
More Information:
Contact: Manager Research Housing and Community Building Division Department of Human Services 50 Lonsdale St Melbourne 3000 Telephone: 61 3 90967715 Email: housing@dhs.vic.gov.au
vii
Executive summary
Expected overall rates of return are critical to investment decisions in rental housing. The internal rate of return (IRR) is a measure of an investments cash flow over its life, expressed as an annual rate. In the case of residential investment, the cash flow has three main components: the initial outlay to purchase the property (including stamp duty and any other transaction costs), the annual net rent and operating costs, and the capital return on sale. The internal rate of return to individual investors for residential investment houses in Melbourne from 1998 to 2009 was, on average, 18.4 per cent. This figure was calculated from a unique model developed by RMIT University on individual properties bought, tenanted and sold during 19982009. The model was used to estimate rates of return for houses and units in Melbourne for a typical individual investor, a large firm and a superannuation fund. The key difference in these models is the tax treatments for each. The period under consideration showed standard variable interest rates fluctuating by over three per cent from their lowest to highest point, including two periods of reduced capital appreciation and lower turnover. Rental vacancies fell over the period to levels where demand far outstripped supply, leading to strong competition among tenants for rental properties and falling turnover. Rents showed significant growth in this low vacancy rate period, yet only induced patchy investment. This growth in rents is particularly reflected in the impact it has had on affordable rentals for lower income households. A chronic shortage of affordable rental properties existed even during periods of rental market expansion. The National Housing Supply Council, in its 2010 report, estimated that in 200708 at a National level there was a shortfall of almost 500,000 rental properties that were both affordable and available for those in the bottom 40 per cent of the income distribution. Internal Rates of Return, all investors, houses and apartments, Melbourne 19982009
Internal rates if return (IRR), all investors, houses and apartments, Melbourne 19982009 Holding Period Years 1 2 3 4 5 6 7 8 9 10 11 Average Investor 17% 17% 19% 18% 18% 18% 19% 20% 20% 19% 19% 18% Houses Company 9% 9% 11% 11% 11% 12% 14% 14% 15% 14% 14% 12% Superfund 6% 6% 7% 7% 7% 8% 9% 9% 10% 9% 9% 7% Investor 21% 15% 15% 13% 12% 13% 15% 16% 17% 17% 17% 15% Units Company 13% 8% 8% 7% 6% 8% 9% 11% 12% 13% 13% 9% Superfund 6% 6% 6% 5% 5% 5% 6% 7% 8% 8% 9% 6%
viii Investment returns from rental housing in Melbourne, 19982009
IRRs for institutional investors such as superannuation funds are considerably lower than those of individual investors and companies. The average IRR for houses over all holding periods was seven per cent for superannuation funds; the comparable figure for units was six per cent. The lower returns to superannuation funds are largely due to their inability to directly leverage their investments and having to commit 100 per cent equity upfront. Recently, new schemes to attract private sector investment into rental housing have been introduced by Australian Governments. The National Rental Affordability Scheme (NRAS) aims to stimulate additional rental investment in the provision of up to 50,000 affordable rental dwellings across Australia by June 2012. Over 10 years NRAS would provide an annual Commonwealth subsidy of $6,000 (indexed to the CPI Rental Index), matched by at least $2000 from the States and Territories, for each dwelling rented to an eligible tenant, provided the rent was no more than 80 per cent of the assessed market rent. In 201011 the subsidy was equivalent to $6,855 at Commonwealth level and $2,285 at State level. The modelling by RMIT University suggests that, in the light of returns from 1998 to 2009, superannuation funds could have achieved both net yields and capital growth, had a scheme like NRAS been in place, even if investing 100 per cent equity upfront. The returns generated in Melbourne between 1998 and 2009 provide compelling evidence that institutional and corporate investors may be able to meet their equity investment benchmarks in the policy climate ushered in by NRAS. IRR for Company and Superannuation fund, with NRAS, by holding period, Melbourne 19982009
Holding Period Years 1 2 3 4 5 6 7 8 9 10 11 Average Investor 17% 17% 19% 18% 18% 18% 19% 20% 20% 19% 19% 18% Houses Company 26% 24% 24% 22% 22% 24% 26% 28% 29% 27% 30% 24% Superfund 9% 9% 10% 9% 10% 10% 12% 12% 13% 12% 13% 10% Investor 21% 15% 15% 13% 12% 13% 15% 16% 17% 17% 17% 15% Units Company 35% 25% 23% 20% 19% 20% 22% 25% 28% 28% 30% 23% Superfund 10% 9% 9% 8% 8% 8% 10% 11% 12% 12% 12% 9%
ix
However, a number of barriers to such investment remain, limiting the extent to which institutional and corporate investors can manage risk. Despite the barriers, these investors may be able to generate higher returns through partnership and shared equity ventures. Superannuation funds, for example, may be able to benefit indirectly from the advantages of leverage by investing in property companies or trusts. They could also develop appropriate shared equity ventures with non-profit organisations such as Victorias Registered HousingAssociations. The data on which this analysis is based covered a relatively short period in a generally buoyant metropolitan property market, with no major price corrections such as occurred in the early 1990s for example. This shortcoming can be remedied over time as successive years data are included. If the Melbourne market during this period was showing unusually high returns, the model can be calibrated to include the likely average variation in rental returns and capital gains over a full property cycle. In any case, if the IRR is low during periods of low capital growth, then the average IRR will be somewhere below the average identified here.
x Investment returns from rental housing in Melbourne, 19982009
Introduction
Expected overall rates of return form one critical driver of the supply of rental housing by investors. It is, therefore, very important to provide potential investors with credible and timely market information on trends in returns. This report does so with respect to the past decade and provides an approach that can be used to track total yield, rental yield and capital gain components of return over the long term. Most individual rental investors are motivated by capital returns rather than rental yields and will choose their investment strategy accordingly. A review of research by the Australian Housing and Urban Research Institute Centre (AHURI)1 showed that rental yield plays a small part in the decisions of investors, who are motivated more or as much by capital gain and taxation advantages. Long-term investment is the most cited reasoning behind residential investment; how long is never made clear. The Australian Bureau of Statistics (ABS) survey of rental investors from 19972 showed that over half of all landlords in 1997 had purchased their property within the previous three years. The decisions of investors to buy or sell their rental investment are largely financial: the anticipation of gain, or the need for funds. Investors must balance the returns perceived from rental housing with the risks of them not being realised. Of particular interest to the Office of Housing is the chronic shortage of rental properties catering for low income earners. Reasons why more investors dont look to this end of the rental market are varied and there is a growing body of evidence on this topic.1,3 Not well researched is whether good market information would assist in changing perceptions about risks and returns associated with affordable rentals.4 This report provides an empirical demonstration of the rate of return on residential investment in Melbourne during 19982009. The scale of return is calculated on actual dwelling investments that were bought, rented and sold during that period. It uses records of individual sales and subsequent lettings from data held by the Valuer-General in Victoria and the Residential Tenancies Bond Authority (RTBA) in Victoria. The AHURI research centre at RMIT University developed a model of the rates of return in rental housing using this data. The model was used to estimate rates of return for houses and units in Melbourne for the typical individual investor. Subsequently, the model was used to estimate the actual rates of return that a company and a superannuation fund investing in rental housing would have received had they invested over the 19982009 period. Finally, potential improvements to rates of return for these cases using the National Rental Affordability Scheme (NRAS) were modelled.
1 2 3 4
Seelig, Tim, et alia, 2006, Motivations of investors in the private rental market, Positioning Paper No 87, AHURI, Melbourne. ABS, 8711.0, Household Investors in Rental Dwellings, Australia June 1997 Short, et alia, 2008, Risk-assessment practices in the private rental sector: implications for low-income renters. Final Report, AHURI, Melbourne. Low income households are typically defined as those whose primary income are Centrelink payments, but also include key workers whose earnings are in the bottom two quintiles of the income distribution. Affordable rentals are those where the households above spend no more than 30 per cent of their income on rent.
2 Investment returns from rental housing in Melbourne, 19982009
There are some limitations to this research, notably the period of study coinciding with generally sustained capital growth in residential housing. However, the quality of the modelling and the detailed data that can be analysed highlight the potential for this project to develop into a comprehensive record of the performance of residential investment in Melbourne. This report updates the data used in the model, and the model itself will be further developed overtime. This report has four sections: The first describes the context for the study: the residential investment market in Melbourne between 1998 and 2009. The second introduces the RMIT IRR model and describes the unique sample of individual investments that provided the data. The third section presents the analysis of investment returns for a representative individual investor, a large company and a superannuation fund. The fourth section presents findings from an adjustment in the model to include the NRAS for the large company and the superannuation fund to identify potential returns that might beavailable. The report concludes with some discussion of the findings and further directions for research using the data in the model.
Context
Residential investment in Melbourne, 19982009
This study uses data from 1998 to 2009 in Melbourne. The housing market in Melbourne in that time was remarkable for its level of activity and capital growth. While the period is considered a property boom, there have been two periods when median house prices declined and stabilised for a time before climbing again. Between 2003 and 2006, and again between mid 2008 and mid 2009, Melbourne house prices did not show strong appreciation compared to 20002002. Chart 1 shows annual percentage change in the ABS house price index for established houses from 19892009. It shows clearly the sustained house price increases through the late 1990s to the end of 2003. The peak in 2001 is comparable to the peak in 1989, but not as steep, the difference being the more sustained growth in prices compared to the steeper but shorter-lived price boom of the late 1980s. Chart 1: ABS Melbourne house price index; 19892009
40% 35% 30% Annual per cent change 25% 20% 15% 10% 5% 0% -5% -10% Jun89 Dec91 Jun94 Dec96 Jun99 Dec01 Jun04 Dec06 Jun09 Jun-07 Jun-09
Source: Australian Bureau of Statistics, 6416.0
Table 1: Volume of sales, metropolitan Melbourne, 19982009

Years 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Total Houses 56,040 59,296 60,145 70,183 66,454 64,871 56,097 59,259 57,630 68,678 53,632 57,734 730,019 Apartments 24,209 28,134 28,659 35,301 30,817 28,496 24,912 27,893 29,477 39,652 28,005 29,730 355,285 Total 80,249 87,430 88,804 105,484 97,271 93,367 81,009 87,152 87,107 108,330 81,637 87,464 1,085,304
Source: Land Victoria, 2010, A Guide to Property Values 2009, Department of Sustainability and Environment, Melbourne.
Table 1 shows the volume of sales during the period of this report as recorded in A Guide to Property Values, the Valuer-Generals official market statistics. Together with Chart 1, it shows the close relationship between volume of property turnover and price growth. In 2001, during the period of greatest price growth, residential property turnover in Melbourne reached 105,484 per annum. In 2004 it was 80,009; nearly 25 per cent fewer. The market then returned to strong sales achieving 108,330 in 2007. This raises the question as to whether this level of turnover volatility might be reduced if there were types of investors in the residential housing market other than individual investors.
Chart 2: Investment in rental housing, Victoria, 19982009

$6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 36% Number of applications/grants 30% 24% 18% 12% 6% 0% 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Investor nance ($m) Investor share all lending (%)
Jun98 Jun99 Jun00 Jun01 Jun02 Jun03 Jun04 Jun05 Jun06 Jun07 Jun08 Jun09
Source: Australian Bureau of Statistics, 5609.0 Housing Finance Australia, Victoria tables
Chart 2 focuses on rental investment in terms of the scale of lending for investment. It shows the volume of money loaned for investment and its proportion of all residential lending (including owner occupation). The chart illustrates how investment closely follows price changes and volumes of property transactions. Of interest is that the value of lending peaks after the greatest rises in prices. The proportion of housing finance going to investment peaked at over 30 per cent in 20022003, falling to below 25 per cent in 20052006. This further illustrates the close relationship between investment, price appreciation and turnover in the market due to investors focus on the level of capital gain. From this, one can surmise that about 25 per cent of the annual turnover in the housing market is for residential investment, say between 20,000 in slow years (e.g. 2004 or 2008) and 26,000 in peak years (e.g. 2001 or 2007). These figures are worth recalling in relation to the sample of investment properties described later in this paper.
Per cent all housing finance
Chart 3: Standard variable home loan interest rate, 19982009

12% 10% 8% 6% 4% 2% 0% Jun98 Jun99 Jun00 Jun01 Jun02 Jun03 Jun04 Jun05 Jun06 Jun07 Jun08 Jun09 Month
Source: Reserve Bank of Australia, F.05 Indicator Lending Rates
Per cent
Chart 3 shows trends in the standard variable home lending interest rate over 19982009. The significance is that interest rates raise the cost of capital and therefore the return on investment. The period under consideration shows interest rates rising by over three and a half per cent between 2001 and 2008, including the period of reduced capital appreciation and lower turnover. This is a 50 per cent increase in borrowing costs over the period.
Melbournes rental market, 19982009

In 1998, the rental market in Victoria consisted of over 230,000 dwellings; by June 2009 there were 373,700 dwellings.5 This was a net increase of 143,700 dwellings mostly provided by small investors joining the property boom and capitalising on tax advantages. From table 1, we can estimate that over 270,000 dwellings from a total of 1,085,304 were acquired by investors between 1998 and 2009 if we adopt the figure of 25 per cent of all property sales were to rental investors, as indicated by Chart 2. The difference between the net growth in rental stock and the estimated dwellings purchased by investors is 126,300, which equates to about 47 per cent of investor purchased dwellings. This analysis points to a significant amount of re-sales within the rental stock indicating that holding periods for some rental investments are only a few years. This may be related to the significant capital growth of the period, and that holding times may be longer in other environments. Chart 4: Melbourne rental vacancy rate (trend), 19982009
6% 5% 4% 3% 2% 1% 0% Jun98 Jun99 Jun00 Jun01 Jun02 Jun03 Jun04 Jun05 Jun06 Jun07 Jun08 Jun09 Jun10
Source: Real Estate Institute of Victoria
Even though investors in the rental market have remained generally strong and active bonds6 continued to grow (see chart 8), in 2009 vacancy rates were well below those of 2001. Chart 4 shows that rental vacancy rates fell over the period to levels where demand far outstripped supply, leading to strong competition among tenants for rental properties and falling turnover. Increased demand for rentals largely resulted from a significant population increase. Note that the period of declining vacancy rates (below 3 per cent) coincided with stable rates of investment and reduced turnover in the rental housing market while population growthsurged.
5 6
These figures represent the total estimated properties with bonds registered at the RTBA. See Office of Housing, Rental Report. http://www.housing.vic.gov.au/publications/reports/rental-report Active bonds refers to tenant bond lodgements currently recorded by the Residential Tenancies Bond Authority (RTBA) under the Residential Tenancies Act and is the most complete measure available of properties being rented.
Chart 5: Annual rate of change in estimated resident population, Victoria 19912009.

2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Jun91 Jun93 Jun95 Jun97 Jun99 Jun01 Jun03 Jun05 Jun07 Jun09
Source: Australian Bureau of Statistics 3201.02 Estimated Resident Population by Single Year of Age, Victoria
Chart 5 shows the annual rate of change in the estimated resident population of Victoria between 1991 and 2009. The sustained levels of growth from 2004 were the equivalent of 1,666 people per week on average. Over this same period from 2004, net overseas migration increased from 43 per cent to 70 per cent of the growth in Victorias population.7 Migration drives population growth of this magnitude and most migrants will tend to rent on arrival, rather than enter homeownership, putting immense pressure on rental markets to respond. Chart 6: Melbourne rent indices (ABS CPI rent component and Metropolitan Rent Index)
14% 12% Annual percentage change 10% 8% 6% 4% 2% 0% Jun99 Jun00 Jun01 Jun02 Jun03 Jun04 Jun05 Jun06 Jun07 Jun08 Jun09 Metropolitan Rent index ABS CPI (rents)
Sources: Office of Housing, Rental Report; Australian Bureau of Statistics6401.0, Consumer Price Index, Australia
ABS, Australian Demographic Changes: Table 2 Population change. Cat No. 3101.02
A strong indicator of changes in the rental sector is the rent indices. Chart 6 shows the rent indices for Melbourne calculated by the ABS and the Office of Housing. Both show an upswing in the rate of change in rents during 20062007. The ABS rental index is calculated as part of the Consumer Price Index and is a matched sample of current rental properties, not new lettings.8 The Office of Housing rent index is a stratified index of the rents of new lettings and is calculated in a similar way to the ABS house price index.9 The difference in the indices rate of change is attributable to their sensitivity to market change, such as rental turnover and rent increases among sitting tenants. In addition, while the Office of Housing index includes all new tenancies, the ABS index uses a sample of tenants, including public housing renters.10 The greater volatility of the Office of Housing index is revealed by the rapid rate of increase in rents (jumping from 4% in March 2006 to 12.7% in September 2007) that was followed by an even more rapid decline from September 2008 as the rate of increase in rents slowed. This reflects its connection with new lettings and the greater likelihood of landlords setting rental increases when establishing new tenancies. Turnover in the rental market was estimated by the Office of Housing to be just over 45 per cent per annum, but falling. Comparing Chart 1, the house price index, with Chart 6, the rent indices, paints a complex picture of fluctuating capital growth potential with a significant period of growth and decline in the rate of increase in rents. Nonetheless, rents continued to increase throughout this low vacancy rate period, yet induced only patchy investment.
8 9
ABS, 6461.0Australian Consumer Price Index Concepts, Sources and Methods, 2009 Office of Housing, Rental Report, June quarter 2009; ABS, 6401.0 Table 13 10 The ABS does not disclose the exact size of the sample of rented properties. However, it does report that the CPI in total is drawn from over 100,000 separate price quotations each quarter. Correspondence from the ABS indicates that there are about 1000 observations for Melbourne each quarter.
Chart 7: Rent frequency distributions, 2000/01, 2004/05 and 2008/09, (real weekly rents $2009)
25,000 20,000 2000/2001 15,000 10,000 5,000 0 $101125 $126150
$151175
2004/2005
2008/2009
$176200
$201225
$226250
$251275
$276300
$301325
$326350
$351375
$376400
$401425
$426450
$451475
$476500
$501525
$526550
$551575
under $100
$576600
600 over 0 and
Source: Office of Housing, unpublished
Chart 7 shows the distribution of rents for new lettings in 200001, 200506 and 200809. There is a clear shift in the distribution of rents, with net declines in new lettings at lower rents and increases at higher rents. Studies for AHURI have illustrated this consistent decline in the level of low rent stock, pointing to high levels of affordability stresses for lower income households11.
11 Judith
Yates, Maryann Wulff, and Margaret Reynolds, 2004, Changes in the supply of and need for low rent dwellings in the private rental market. Final Report, AHURI, Melbourne.
over $600
11
Chart 8: Total active bonds metropolitan Melbourne, 19992009

300,000
Number of active bonds
250,000
200,000
150,000 Jun99 Jun00 Jun01 Jun02 Jun03 Jun04 Jun05 Jun06 Jun07 Jun08 Jun09
Source: Office of Housing, unpublished
14,000 12,000 10,000 8,000 6,000 4,000 2,000 0
It is worth noting that the increase in rents depicted in Chart 7 has resulted in a shortage of affordable rentals rental properties, even during periods of rental property expansion as demonstrated by Chart 8. It is also apparent from Chart 8 that active bonds (i.e. rental properties) continued to enter the market during the time of decreasing vacancy rates and did so at a slightly increasing rate from June 2001 onwards.
Policy context
Rental assistance for lower income households in Victoria consists primarily of the Office of Housing providing or funding income-related rents for social housing and bond assistance, and the availability of rent assistance to Centrelink income support recipients renting privately (Commonwealth Rent Assistance). Rent assistance is an income supplement and is not primarily intended as an affordability payment, or an incentive to induce rental supply. Policy changes in Victoria since 19992000 have established the grounds for the expansion of the social rental sector using leveraged capital12. In 2005, Victoria introduced a system of registered affordable housing providers, and committed funding towards the expansion of this non-profit sector.
12 The
Social Housing Innovations Project (SHIP) began in 1999 with $94.5 million in additional capital for innovative joint venture projects with the Office of Housing. The project foreshadowed the introduction of independent housing associations, since realised with the establishment of the Registrar of Housing Providers and the 2005 amendments to the Housing Act 1983.
Given the shortage of affordable rental accommodation, there is a clearly-identified need to encourage private sector participation in this market. However, inducing new affordable private rental supply with a subsidy requires that it be directed to investors who would not otherwise be in the market. Additional investment should not crowd out other investors, which would merely lead to price rises by expanding demand for the same properties13.
Barriers to institutional Rental Investment

Research by AHURI has shown the basic barrier to attracting large scale investment into rental housing is the gap between the rental yields investors require in order to bear risks and the rents actually available in different rental sub-markets14. Beyond this market rent gap, a further affordable rent gap exists between current market rents and the rents that lower income tenants can reasonably afford to pay and still have sufficient disposable income to meet the other necessities of life. These two gaps are illustrated schematically in figure 1. Figure 1: The Affordable Rent Gap.
Required Rent Market rent gap Market Rent Affordable rent gap Affordable Rent
Source: Berry and Hall, 2002, New approaches to expanding the supply of affordable housing in Australia: an increasing role for the private sector. Final Report, AHURI, Melbourne. Figure 3.1 p 24.
13 See
Viggo Nordvic, 2006, Selective housing policy in local housing markets and the supply of housing. Journal of Housing Economics, 15; 279292. 14 Mike Berry (with the assistance of Jon Hall), 2002, New approaches to expanding the supply of affordable housing in Australia: an increasing role for the private sector. Final Report, AHURI, Melbourne.
13
Market rents are determined in imperfect markets where small investor-landlords supply dwellings for a range of reasons in an environment where chronic shortages and surpluses characterise different market segments. The level of affordable rents depends on the income of individual tenants. An institutional investors required rent may be significantly higher than market (and, of course, affordable) rents since it would have to compensate investors for a range of risks associated with housing investment not commonly factored by individual investors. These include: Capital risks associated with resale (capital gains), including expected house price changes, adequate maintenance and protection of the dwelling from damage; Revenue risks associated with rental collection and managing vacancies and rental arrears; Operating risks associated with the costs of and availability of effective tenancy and propertymanagement; Reputational risk associated with potential tenant eviction; and Political or policy risk associated with possible future changes in government policy orregulation. In addition, required rents will reflect a number of current barriers in the residential property sector: Illiquidity the high transaction costs associated with buying and selling dwellings; Lack of scale the high transaction costs associated with dealing at the level of singledwellings; and Lack of reliable and robust market information on actual rental yields and capital gains. It is this last factor that has, to date, proved decisive in dissuading institutional investors, particularly superannuation funds, from investing equity in rental housing. The data have not been available in a form that would allow risk to be properly priced and the required rent established for alternative rental investment opportunities. For example, available house price and rent indices are not integrated and most price data is aggregated at too high a geographical scale. In the absence of appropriate returns data, the required rent, if stated at all, is likely to include a substantial uncertainty premium. But if reliable data could be found, any premium in rents for uncertainty may be much smaller allowing required rents to fall, somewhat reducing the market rent gap. Required rent will fall further if ways can be found to reduce the risks and barriers already noted. Conversely, rents affordable by lower income tenants can be increased by various policy interventions, notably by the provision of targeted subsidies. The aim here is to remove the existing market and affordable rent gaps facing potential institutional investors by bringing required rent down and affordable rent up, until they meet.
The National Rental Affordability Scheme

The National Affordable Rental Scheme (NRAS) aims to stimulate additional rental investment in the provision of up to 50,000 affordable rental dwellings across Australia by June 2012. NRAS will provide an annual Commonwealth subsidy of $6,000 (indexed to the CPI Rent index) matched by at least $2,000 from the States and Territories, for each dwelling rented to an eligible tenant, provided the rent is no more than 80 per cent of market rent. In 201011, the subsidy was equivalent to $6,855 at Commonwealth level and $2,285 at the State level. The Commonwealth subsidy will be provided in the form of a tax credit or, in some circumstances, a cash grant. The State and Territory subsidy can be provided in cash or in-kind. The key effect will be to increase the net after-tax yield to investors. The Victorian Government has committed to fund 8,500 new affordable rental dwellings through the NRAS scheme as at the date of this report.
15
Rates of return for Melbournes rental housing, 19982009

The research reported here aims to enhance the information available on rental returns and close some of the uncertainty risks of the required rent gap, noted previously. Evidence of returns from rental housing has typically been taken from analyses based on averages, or non-representative samples, such as individual investors experience15. These have not been sufficiently detailed or credible as accurate measures of rental yields. A systematic and representative study of a large number of individual rental properties has not been available, until now. A dataset of actual rental properties bought and sold in Melbourne during1998-2009 has been compiled that allows for the estimation of actual rates of returninthe rental market.
The method the internal rate of return

The internal rate of return (IRR) for rental investment is a measure of the yield of properties. Yield is based on the rental income, capital growth, acquisition, disposal, and operating costs spread over the duration of the holding. It measures the average annual yield of the cash flows accruing to an investment over the life of the investment in constant dollars and is used to compare the relative returns of different investment strategies. An IRR above the cash rate would indicate a positive investment. For rental housing there are typically three elements to cash flow. These are the: Initial acquisition of the asset; Annual net rental income; and After-tax capital return at sale. These cash flows can vary significantly within the rental market, depending on the level of equity invested, the cost of capital, the rental return, tax arrangements, and the level of capital appreciation in the housing market.
The model RMIT IRR

The AHURI Research Centre at RMIT University has developed a model to calculate the IRR that would have accrued owning, renting and selling dwellings in Melbourne during 19982009 by three hypothetical representative investors: A typical individual investor; A large company; and A superannuation fund. We can distinguish the models assumptions between those related to the inputs for calculating the IRR (prices and rents), and those related to the three investor types16. These assumptions are conservative, suggesting that the estimated returns may be on the low side.
15 Returns
to residential investment have been estimated by the Real Estate Institute of Australia using average yields (see Market Facts) 16The specific technical elements of the modelling undertaken by RMIT University are included in theAppendices. The assumptions and sources used for calculating average operating expenses and land tax are noted in Appendix 2. The ways in which the IRR model treats taxation, debt and transaction costs are noted inAppendix 3.
Input assumptions
The input assumptions for the model that relate to the data and how they are adjusted for various factors, such as time and tax, are: Property values change linearly between purchase and sale; Initial rents increase annually by the Melbourne CPI rent index; Average vacancy rate of 1.6 per cent is assumed for all properties; and 2007 income and land tax schedules apply for the whole period although there have been changes during the period 1998 to 2009.
Investor-type assumptions
The following table illustrates the differences between the three modelled investors: Table 2: Investor Assumptions for RMIT IRR Model
Individual Equity (per cent) Debt (per cent) Finance Income tax rate (per cent) Capital gains tax Land tax 15 85 Standard 25 year 46.5 50 per cent discount on nominal gain Exempt Company 15 85 Standard 25 year 30 No discount Maximum (3 per cent) Superfund 100 0 0 15 33.3 per cent discount Maximum (3 per cent)
The analysis of rental returns focused first on the returns available to the typical rental investor in Melbourne: individuals or couples with one or few rental properties and other sources of income, as these are the people who would have realised these returns. The analysis then models variations that reflect the returns available to a large company and a superannuation fund had they made the same investments.
17
The sample matched sales and rentals

The analysis presented here is based on actual sales data for houses and units/apartments acquired and sold between 1 July 1998 and 30 June 2009. These sales data have been matched, on an individual dwelling basis, with dwellings on which rental bonds were lodged with the Rental Tenancies Bond Authority (RTBA), giving a sample of rental dwellings acquired, rented and sold over the period.
Representativeness, Exclusions and outliers

The sample does not include property bought prior to 1998, property let prior to 1998 and rented during the period, or property bought but not sold. Properties held for less than one year were removed from the sample. Outliers in terms of capital gains realised have been omitted, resulting in a total sample of 171,868, comprising 102,128 houses and 69,740 units/ apartments. If we recall the estimate of turnover of 126,300 rental properties calculated previously the sample size appears to be comprehensive. Table 3: Sample size by holding period
Holding Period (years) 1 2 3 4 5 6 7 8 9 10 11 Total Houses 15,644 20,350 18,142 14,800 11,620 8,566 5,736 3,786 2,210 1,010 264 102,128 Units 10,370 12,136 11,532 9,968 8,244 6,758 4,874 3,070 1,716 858 214 69,740 All 26,014 32,486 29,674 24,768 19,864 15,324 10,610 6,856 3,926 1,868 478 171,868
The sample is a very close representation of properties bought and sold during the period, but it is less easy to identify how well it represents all rental investment in Melbourne over the period. This is a project for further analysis to identify where the sample sits in the housing market and the rental market, by price and location. Finally, as the sample improves through successive additions to the data, the applicability of these results to the rest of the market and perhaps rental investment in Australia will become more reliable.
Analysis IRR for hypothetical rental investors Melbourne 19982009

Table 4 presents the IRR calculations for the individual, company and superannuation fund investors for both houses and units for holding periods ranging from one to eleven years. Table 4: Internal Rates of Return, all investors, houses and apartments
Individual investors
The individual investor used in this model holds one property, borrows 85 per cent of the purchase price, is taxed at the highest marginal tax rate and is exempt from land tax. As long as the total value of land holdings falls below given thresholds (as assumed in the base case), the investor avoids land tax. The 85 per cent gearing ratio means the typical landlord with such leverage suffers a net rental loss ($4,750 on houses and $3,597 for units from table A3.5). The top rate investor is able to deduct this deficit from other sources of income, thus slashing its tax bill by 46.5 cents for every dollar that it deducts.
Key Findings individual investors

The average IRR for all houses held and sold over the 19982009 period was 18percent. The comparable IRR for units was 15 per cent. Rental investors are able to use tax deductible borrowings to leverage the acquisition of an asset with strong capital growth that benefits from lenient tax treatment of capital gains. These gains swamp the small negative running net cash outflows during the holding period. This strong relationship between IRRs, holding period and capital gains is summarised in Appendix 4. Under current market and policy settings, as described, it is easy to see why rental investment is dominated by high marginal tax paying investors owning a small number ofproperties.
19
Rates of return for individuals vary according to the stage in the property cycle that dwellings are bought and sold. Full details of these business cycle-related findings are shown in Tables A4.1 and A4.2 in Appendix 4. Dwellings purchased between 1998 and 2001 and sold by 2003, for example, had IRRs of almost 30 per cent, while properties purchased and sold between 2003 and 2006 had lower IRRs, picking up again if held longer. The importance of the capital appreciation is seen in the low IRRs for properties bought and sold between 2003 and 2006 with short holding periods. As the holding period extends, and market values improved, the IRRs rise towards the average. The high average rates of return to an individual investor hide the underlying pattern of cash flows through time: At the start of the investment project there is a net cash outflow, but because of the 85 per cent loan-to-value ratio the net cash outflow is small relative to the capital value of the asset. In the years between acquisition and sale there are net cash outflows that are steady as the holding period lengthens. The cash outflows are small they rarely exceed $2000 per annum as their burden on investors is curbed by negative gearing that cuts this outflow by nearly one-half, given a marginal income tax rate of 46.5 per cent. In the final year there are large cash inflows as investors cash in capital gains that are largely pocketed because of their lenient tax treatment. (Tables A4.3 and A4.4 in Appendix 4 provide the relevant details.) Table 5 reveals that IRRs are highest for those properties in the lowest rent decile, and gradually decrease with increasing rent 25 per cent for the second lowest decile to 13 and 14 per cent for rent deciles 8 and above. A similar trend is apparent for Super fund modelling indicating this is not an aberration of the more lenient tax treatment specific to individual investors.
Table 5: Comparison of IRR by gross rent deciles: all dwellings held 5 or more years17
Gross Rent ($) 7,449 8,727 9,490 10,280 11,164 12,307 13,698 15,544 18,427 28,283 13,785 Gross Rental Yield (%) 6.48 10.22 6.63 6.66 6.60 6.87 6.70 6.74 6.65 7.63 7.10 IRR Base Case IRR Super Fund (Individual with Highest Land Investor) Tax Rate 22% 25% 18% 18% 17% 17% 15% 15% 13% 14% 17.24% 9.37% 10.85% 8.09% 7.85% 7.63% 7.67% 7.02% 6.74% 6.32% 6.48% 7.73%
Rent Decile 1 2 3 4 5 6 7 8 9 10 Mean
Purchase Price ($) 124,450 132,217 146,837 158,049 176,287 187,650 215,957 247,203 296,312 433,956 215,773
Company investors
The modelling investigated the hypothetical returns to a company that invested in rental properties over the period. The company investor is similar to the individual investor in that it uses 85 per cent leverage but differs in the tax treatment for annual cash flows. The resulting IRRs are generally lower, due to the lower marginal tax rate reducing the deductibility of rental losses and the lack of a capital gains tax discount.
Key Findings company investors

The overall average IRR for all houses held and sold over the 19982009 period was 12 per cent (table 4). The comparable IRR for units was 9 per cent. The temporal pattern of IRR for houses and units generally rises the longer dwellings areheld.
17
Properties have been ranked by their gross rental in the first year of the investment adjusted to 2009 CPI dollars. Rent decile 1 indicates the lowest 10 per cent of rents in any year. Only properties held for 5 years or more are included for comparative purposes.
21
The returns to large-scale corporate investment in housing over the period would have been lower than returns accruing to individuals. This follows from the impact of land tax levied on each dwelling held. Nevertheless, returns to corporate investors would still have been high, especially on houses held for longer periods. The lower marginal tax rate does not reduce returns since the smaller tax savings from negative gearing are more than offset by a reduction in capital gains tax liability on final sale. Equally, corporate investors would have incurred negative net annual cash flows over the holding period, averaging around $3,700 per dwelling, due to both the impact of land tax and borrowing costs on 85 per cent of the purchase price. The temporal pattern of cash flows is presented in Tables A4.5 and A4.6 in Appendix 4. This analysis suggests that actual returns to large-scale investment in residential property by corporate ventures over the period in question would have suited investors with an appetite for capital growth and a willingness to embrace negative gearing.
Superannuation fund Investors

The model considered returns that would have accrued to a superannuation fund investing at scale over this period, assuming that no borrowing was undertaken18. Institutional investors, such as superannuation funds, typically, are yield-driven by the annual rental return from their commercial property investments rather than capital gain driven. It is therefore unlikely they would accept all, or the bulk of expected returns, in the form of capital gains on housing. Moreover, by investing in large tranches of dwellings, such investors would be subject to land tax at the top rate, reducing overall IRRs and decreasing the net yield.
Key Findings superannuation fund investors

IRRs are considerably lower than for both individual investors and companies: the average IRR for houses over all holding periods is 7 per cent; the comparable figure for units is 6 per cent (Table 4). IRRs increase with holding period: thus, the return for houses rises from around 6 per cent when the property is held for only one year to over 9 per cent when held for eleven years; a similar but slower rate of increase in returns was noted for units (see Tables A4.7 and A4.8 in Appendix 4 for cash flows). Although gross rental yields averaged under six per cent for both houses and units19, net after-tax rental cash flows were positive but low (around one to two per cent) for superannuation fund investors.
18 Superannuation
funds are prohibited from borrowing for investment under Section 67 of the Superannuation Industry (Supervision) Act 1993 19 These gross rental yields are calculated with respect to the capital value at purchase and may not be representative of the yield throughout the investors holding period see table A3.5
The lower returns to superannuation funds are largely due to their inability to directly leverage their investments and must commit 100 per cent equity upfront. The improving rates of return with holding period arise because the fund benefits from purchasing dwellings at lower prices in the early years. This case suggests that, even during a buoyant period in housing markets, superannuation funds would be unlikely to invest in this sector. The IRR, though moderately high by comparison to the risk-free rate of return and somewhat comparable to other equity opportunities, is accompanied by a low net yield. Most of the return is dependent on capital growth. This poses a considerable challenge for policy makers if the market and affordable rent gaps are to be closed and superannuation funds and other large investors attracted into this new asset arena. The following section examines one policy approach to closing this gap.
23
Closing the rental gaps NRAS

Raising the net revenue accruing to large investors like superannuation funds while ensuring that rents paid by tenants are affordable can be approached by bundling in appropriate government subsidies. The IRR model was amended to include an $8000 NRAS subsidy to the company and superannuation fund cases, and a discount to 80 per cent of market rent. The impact on IRR and net yield were then compared to the standard case. Table 6 presents the IRR calculations for the different holding periods for the company investor and superannuation fund, with the individual investor for comparison. Table 6: IRR for Company and Superannuation fund, with NRAS, by holding period, Melbourne 19982009
A company investor with NRAS

The assumptions for the company investor are the same as used previously except that a taxfree cash subsidy of $8000 per year is added to the net after tax rent cash flow for each year that a dwelling is held (up to 10 years) and rents are discounted by 20 per cent.
Key Findings company investor with NRAS

The IRRs are considerably higher than for the standard comparable case: the average IRR for houses over all holding periods is 24 per cent; the comparable figure for units is 23 per cent. Net after-tax rental cash flows are positive at around $3000 per year. This represents an annual return on initial average investment of around eight per cent for houses and nine percent for units, remembering that the investor is only committing 15 per cent of the initial purchase price plus stamp duty (for details see Tables A4.9 and A4.10 in Appendix 4). This analysis demonstrates that a highly-leveraged company investor, holding a large portfolio of NRAS-subsidised rental dwellings over the period in question would have reaped a very high IRR and enjoyed a substantial net cash flow.
A superannuation fund investor with NRAS

The NRAS modelling assumptions are the same as for the previous superannuation fund calculations, except that a tax free cash subsidy of $8000 per year is added to the net after tax rent cash flow for each year that a dwelling is held (up to 10 years) and rents are discounted by 20 per cent.
Key Findings superannuation fund investor with NRAS

IRRs are moderately higher than for the standard comparable case: the average IRR for houses over all holding periods is 10 per cent; the comparable figure for units is 9 per cent. Net after-tax rental cash flows are positive at around $9000 per year. This represents an annual return on initial average investment of around 4.5 per cent (for details see Tables A4.11 and A4.12 in Appendix 4). IRRs, especially for houses, tend to rise with respect to the length of the holding period. If superannuation funds had held houses (units) for five years or longer, the average IRR would have been 12 per cent20 (10 per cent) with an average positive annual net cash flow of $8,940 ($8,997) a dividend of 5.3 per cent (5.3 per cent) on the average initial purchase price (equity advanced). This analysis suggests that, in the light of actual rental residential investment returns over 19982009, superannuation funds could have achieved both significant net yields and capital growth had a scheme like NRAS been in place even if investing 100 per cent equityupfront.
20
See table 6
25
Conclusion Some further considerations

The returns generated in Melbournes rental market between 1998 and 2009 provide compelling and reliable evidence that institutional and corporate investors may be able to meet their equity investment benchmarks in the new policy climate being ushered in by NRAS. However, a number of barriers to such investment remain, limiting the extent to which these investors can manage risk. And the NRAS subsidies are tied to dwellings that must be let at submarket rents for ten years. Investors may be able to generate higher returns through partnership and shared equity ventures. Superannuation funds, for example, may be able to benefit indirectly from the advantages of leverage by investing in property companies or trusts. They could also invest through appropriate shared equity ventures with non-profit organisations such as Victorias Registered Housing Associations21. Partnering with Housing Associations could also help to manage the risks previously identified, including those relating to tenancy and property management.
Continuing the analysis

The data on which this analysis is based covers a relatively short period, focused on a generally buoyant metropolitan property market, with no major price corrections such as occurred in the early 1990s for example. This shortcoming can be remedied over time as successive years data are integrated. If, indeed, the Melbourne market during this period was showing unusually high returns, the model can be calibrated to include the likely average variation in rental returns and capital gains over a full property cycle. In any case, if the IRR is low during periods of low or negative capital growth, then the average IRR will be somewhere below the levels identified here. Current house price and rental patterns would seem to indicate that in the near term, rental returns will be driven more by rental yields (see chart 5) than capital gains. The likely consequence of this is a convergence in the internal rate of return to individual investors and superannuation funds. This likely convergence in returns is due to the differential impact of current taxation arrangements. The Office of Housing has on-going access to the data used in this report and further research and modelling proposals are being developed. In particular, more analysis of the relationship between the property market and rental demand can be developed, as well as the likely rates of return and yields obtainable under shared investment arrangements between superannuation funds and housing associations. Feedback from readers interested in this research is welcomed to advance the direction of findings and to provide better information to the residential investment sector (see page vi for contact details).
21 Housing
Associations are registered under the 2005 amendment to the Housing Act 1983. See www.housingregistrar.vic.gov.au
Appendix 1: Constructing the sample

All rental dwellings bought and sold during 1998 to 2009 were identified by matching two data sets on the address fields: residential property sales recorded by the Victorian Valuer-General and rental levels noted on bonds lodged with the Residential Tenancies Bond Authority. Address information fields provided in each of the data sources were significantly reformatted to derive one unique string field used to identify individual properties. The period of the data analysed is limited to 19982009, as the RTBA only commenced operations in 1998, and the most recent full year of sales data is now 2009. The datasets were sorted into years over this period. Where a property was sold more than once in a year, or more than once over the period 1998 to 2009, records were reduced to show only the most recent sale details. Similarly, where a property was leased more than once in a year, or more than once over the period 1998 to 2009, the records were reduced to show an annualised rent reflecting the most recent lease. Within the property sale records, all instances where a property was sold in one year and resold at a later point in the period (repeat sales) were identified. These repeat sales records were then matched against the RTBA data to identify those properties leased between the points of initial and subsequent sale. Matches were made to the first lease during the holding period and the last lease during the holding period (if different). This subset of properties allows measurement of the actual capital gain/return because the property has been bought and sold by the investor. It also allows for measurement of the rental return because the property has been leased to a tenant. The final sample composition is outlined in Tables A1.1 to A1.3. A total of 476 outliers were removed to form the final sample used for analysis.
Table A1.1: Final sample numbers (excluding outliers) houses by purchase and sale years
Sale Year 2002 1,954 14,360 15,922 15,060 15,522 13,934 11,022 6,754 4,766 2,594 1,966 228 102,128 2,472 2,606 2,202 0 0 0 0 0 0 0 11,656 10,946 12,780 9,754 17,692 11,894 5,806 0 0 0 0 0 0 228 0 0 0 0 0 1,150 816 0 0 0 0 1,124 1,004 466 0 0 0 642 2,100 1,416 608 0 0 1,144 1,224 2,328 1,404 654 0 1,490 2,364 1,824 2,880 1,728 736 2,342 2,508 2,490 1,710 2,666 1,564 654 3,020 2,378 2,248 1,486 2,352 1,276 560 2,432 1,800 1,858 1,116 1,718 1,024 416 2,196 1,562 1,590 1,002 1,452 722 404 1,666 1,208 1,086 750 1,072 606 264 2003 2004 2005 2006 2007 2008 2009 Total
1999
2000
2001
1998
1,464
1,954
2,336
1999
1,768
2,754
2000
2,090
2001
2002
2003
Purchase Year
2004
2005
2006
2007
2008
Total
1,464
3,722
7,180
9,234
Table A1.2: Final sample numbers (excluding outliers) units/apartments by purchase and sale years
Sale Year 2002 1,332 1,748 1,804 1,970 0 0 0 0 0 0 0 6,854 0 6,796 0 0 0 0 0 6,994 0 0 0 0 0 788 1,058 570 0 0 0 0 8,180 1,244 1,200 1,482 1,802 1,626 1,694 1,292 1,184 852 544 338 0 0 0 6,386 1,458 1,374 1,396 940 1,318 1,186 1,200 760 974 820 780 476 714 1,074 1,342 2,040 1,878 1,530 1,320 1,172 492 0 0 11,562 2003 2004 2005 2006 2007 2008 484 664 934 1,408 1,324 1,042 1,030 1,012 602 644 0 9,144 2009 214 374 338 586 584 434 476 506 326 532 182 4,552 Total 9,890 11,702 11,384 12,418 8,896 5,704 3,940 3,028 1,420 1,176 182 69,740
27
1999
2000
2001
1998
1,022
1,366
1,708
1999
1,322
2,056
2000
1,798
2001
2002
2003
Purchase Year
2004
2005
2006
2007
2008
Total
1,022
2,688
5,562
Table A1.3: Final sample numbers (excluding outliers) all property types by purchase and sale years
Sale Year 2002 3,286 24,250 27,624 26,444 27,940 22,830 16,726 10,694 7,794 4,014 3,142 410 171,868 4,220 4,410 4,172 0 0 0 0 0 0 0 18,452 17,940 20,960 16,140 29,254 21,038 10,358 0 0 0 0 0 0 410 0 0 0 0 0 1,794 1,348 0 0 0 0 1,616 1,606 792 0 0 0 980 3,272 2,428 1,114 0 0 1,714 1,768 3,648 2,434 1,130 0 2,278 3,422 2,676 4,410 2,770 1,170 3,586 3,708 3,972 2,894 4,544 2,888 1,238 4,822 4,004 3,942 2,778 4,392 2,684 1,146 3,890 3,174 3,254 2,056 3,060 1,958 754 3,514 2,748 2,790 1,762 2,526 1,386 778 2,640 2,028 1,866 1,226 1,786 1,090 478 2003 2004 2005 2006 2007 2008 2009 Total
1999
2000
2001
1998
2,486
3,320
4,044
1999
3,090
4,810
2000
3,888
2001
2002
2003
Purchase Year
2004
2005
2006
2007
2008
Total
2,486
6,410
12,742
16,088
29
Appendix 2: Structure of the IRR model

The internal rate of return model is derived using a standard econometric method. The following illustrates its basic construction and refinements to meet local conditions. Let: R1, R2.. Rn = Future stream of rents V0 = Initial acquisition price or value on sale C1, C2.. Cn = operating costs that include maintenance, land taxes, rates (and interest payments on debt, see below) N = Expected holding period. Then the internal rate of return is the discount rate r that ensures (ignoring sales proceeds, taxation, debt, transaction costs and subsidies that are introduced later) that:
The Introduction of Taxation On Rental Income

The basic model is refined by including the marginal rate of taxation on rental income. Let:
= the marginal income tax rate of the landlord, then
The Introduction of Debt

As most rental investment is funded by borrowings, the model is refined with a factor for debt. Let: Lo = the loan outstanding at the onset (time = zero) REPAYt = repayments in period t on an interest-only loan.
The Introduction of Capital Gains Tax

Suppose that on resale the proceeds are Vn and capital gains tax is applied to realised capital gains. The capital gains tax liability is the product of the investors marginal income tax rate and one half capital gains. The solution to the IRR is now obtained from
The Introduction of Transaction Costs and Subsidies

For the purchase of rental properties, the principal transaction cost is stamp duty. Transaction costs such as stamp duty are added to other acquisition costs (V0) to arrive at the cost base used to calculate capital gains for tax purposes.
Where S0 = stamp duties payable upon acquisition; Bn = the real estate agent fee on sale; and
= the vacancy rate and property management and letting fees as percentage of gross rent.
Model Input Assumptions
Transaction Costs Stamp duty The Victorian stamp duty schedule is applied to year of purchase Victorian Stamp Duty schedule22
Dutiable value range $0$20,000 $20,001$115,000 $115,001$870,000 $870,000 and over Stamp Duty Rate 1.4 per cent of the dutiable value of the property $280 plus 2.4 per cent of the dutiable value in excess of $20,000 $2,560 plus 6 per cent of the dutiable value in excess of $115,000 5.5 per cent of the dutiable value
22 Stamp
duty rates used were for dutiable properties purchased between 21 April, 1998 5th May, 2008 and can be viewed at http://www.sro.vic.gov.au/sro/SROWebSite.nsf/taxes%20rates.htm
31
Brokerage/selling fees Fees associated with the purchase and sale of the property are estimated at 3.5 per cent of the property value at time of sale. Operating Costs Maintenance fees Maintenance expenditures for investors are based on the mean expenditure by property value/ State segment, obtained from the 1999 Australian Housing Survey and the 1997 Rental Investors Survey, and increased to 2007 values by actual CPI increases. Property management fees Property management fees are assumed to be 11 per cent of the annual gross rent. This percentage is an average of management fees, derived from a survey of Victorian property management agencies. Building insurance Building insurance is assumed to be 0.2 per cent of the value of the building. Land tax Land tax is a deductible State tax based on land value as a percentage of either the purchase or sale prices (in those years), and in the intervening years, of the assumed property value. The land value is based on: Separation of units, houses Differentiation by local government areas Current Victorian land tax schedules are applied. For the superannuation case, the highest marginal rate is applied uniformly. Land Tax Schedule Victoria (2009) General Rate23
Total Taxable Value of Land Holdings < $250,000 $250,000 to < $600,000 $600,000 to < $1,000,000 $1,000,000 to < $1,800,000 $1,800,000 to < $3,000,000 $3,000,000 and over Land Tax Payable Nil $275 plus 0.2 per cent of amount > $250,000 $975 plus 0.5 per cent of amount > $600,000 $2,975 plus 0.8 per cent of amount > $1,000,000 $9,375 plus 1.3 per cent of amount > $1,800,000 $24,975 plus 2.25 per cent of amount > $3,000,000
23 Current
land tax rates can be viewed at http://www.sro.vic.gov.au/sro/SROWebSite.nsf/taxes%20rates.htm
Local government charges Local government rates and charges are based on average property taxes by property value/ State segment from the ABS 200203 Survey of Income and Housing Costs and increased by actual CPI changes to 2009 values. Key Assumptions and Parameters Equity contribution An equity contribution of 15 per cent of the purchase price is assumed for the individual and company, as analyses using HILDA shows the average landlord equity contribution to be 15per cent24. Property values Property values are assumed to change linearly between purchase and sale Rental income Rental income has been annualised for each year, based on the most recent lease applicable to the year (e.g. if the property is re-let in a year, the latter rent is applied throughout the year). Where a lease extends for more than one year, its rent in later years has been up-rated based on the rental index used previously. Rental vacancy rate State-specific vacancy rates from September 2006 were used to reduce all annual rents. The rate used for Victoria is 1.3 per cent. This is equivalent to approximately one weeks rent. Marginal Income Tax Rates The highest marginal income tax rate (45 per cent plus 1.5 per cent Medicare levy) is assumed for all individual property owners and 15 per cent for superannuation funds. From 1998 to 2009 there were changes in tax rates but it is assumed that 2009 schedules apply for the whole period Capital gains tax (CGT) for individuals There is no separate tax on capital gains as it is a component of taxable income and taxed at the marginal tax rate of an individual. Only net capital gains enter taxable income. Net capital gains are defined as total capital gains for the year minus total capital losses (including any net capital losses from previous years) minus any entitlement to a CGT discount and CGT small business concessions. Capital gains or capital losses on an asset acquired before 20September 1985 are not included in net capital gains. In addition, a CGT discount applies to assets that have been acquired after 11.45am (ACT) 21 September 1999 and have been held for at least 12 months prior to the CGT event. A discount of 50 per cent applies to the net capital gain.
24 HILDA
is the Housing, Income and Labour Dynamics in Australia longitudinal household survey begun in 2001. It is funded by the Commonwealth Department of Families, Housing, Community Services and Indigenous Affairs and managed by the Melbourne Institute of Applied Economic and Social Research at the University of Melbourne. See www.melbourneinstitute.com/hilda/
33
Capital gains tax treatment of superannuation funds All super funds other than State and Commonwealth Government super funds pay income tax at a rate of 15 per cent and receive a discount of 33.3 per cent on capital gains if the asset is held for more than 12 months. A superannuation fund paying current pensions is entitled to a tax exemption for the normal assessable income derived from the assets of the fund supporting its current pension liabilities. Any capital gain or loss that a complying superannuation fund makes from a CGT event happening to a "segregated current pension asset" is disregarded. In addition, where assets used solely to produce exempt current pension income are disposed of, any capital gain or capital loss is disregarded. A segregated current pension asset provides revenue to an active pension stream. Exclusions Excluded from the costs on the grounds of difficulty in making reliable estimates are depreciation on amenities (e.g. kitchen installations such as fridges) contained in the property when acquired (or subsequently added), and the Capital Works Deduction. In this latter case the deduction was not used because no data was available on the age of properties in the sample. In any case, the impacts of both the depreciation and Capital Works Deduction are likely to be small. The Capital Works Deduction yields tax gains during the holding period, but the sum of the annual Capital Works Deductions is subtracted from the property cost base when the property is sold. Hence, tax gains derived during the holding period are in part re-claimed by the government through capital gains tax at the end of the holding period. The omission of both these tax preferences results in conservative estimates of internal rates of return.
Appendix 3: Capital gain and rental yield

The following tables summarise the average gross rental yields and nominal capital gains achieved for each purchase and sale period.
Capital gain
The capital gain is derived from the difference between the propertys purchase price (investment value) and subsequent sale price. To compute the average annual capital return, the capital gain is expressed as a proportion of the average amount of capital that is tied up in the investment (the average of the purchase price and the sale price). This is then converted into a percentage, and divided by the number of years of ownership (the holding period). This equation is set out below.
Where HP1 is the purchase price and HP2 is the sale price.
Rental yield
The average annual rental return is derived from the annualised rental income for the property during the years that the investment was held. For properties held more than one year it is unrealistic to assume that the annual rent remains constant at its value at the time the rent is recorded with the lodgement of the rental bond. In some cases, but certainly not all, there is a second (or further) lease agreement and/or rent rise. For those cases with an ongoing tenancy across the holding period, we have imputed the annual rent in each year of the holding period by adjusting the rent using the ABS Rent Index component of the Consumer Price Index (CPI). The index is set equal to one in 1998 (JuneQuarter). The rental return is calculated by first computing the average annual rent as obtained by summing the annual rent in the first and last years of the holding period, and dividing by two. This is then divided by the average amount of capital that is tied up in the investment, and then converted into a percentage. More formally, the equation is set out below.
Where Ann Rent1 is the annualised weekly rent in the first year of the investment, and Ann Rent2 is the annualised weekly rent in the last year of the investment.
35
The average value of cash flows derived from the sample are summarised in Table A3.5. Large capital gains have typically been generated on these property investments over the time frame examined. At $116,919 for houses and $70,257 for units, these capital gains are 48 per cent (33 per cent) of the average purchase price of houses (units). More importantly, these gains are a multiple of the initial cash outlay (equity plus stamp duty) that leveraged investors typically make from their own pockets the capital gain is 2.5 (1.8) times the average cash outlay for investors in houses (units). This concentration of returns in the form of capital gain is important because capital gains are leniently taxed by comparison with ordinary sources of income. See Tables 3.1 to 3.5, following.
Table A3.1: Nominal median annual gross rental return by purchase and sale years houses (Base case)
Sale Year 2002 6.2 6.2 5.5 5.3 4.9 4.7 4.4 4.4 4.3 4.3 4.1 3.9 5.0 5.9 5.7 5.2 . . . . . . . 5.8 5.2 5.0 4.8 4.7 4.6 4.4 4.5 . . . . . . 3.9 . . . . . 4.0 4.2 . . . . 4.2 4.3 4.4 . . . 4.2 4.3 4.3 4.4 . . 4.3 4.5 4.4 4.5 4.6 . 4.4 4.4 4.4 4.4 4.4 4.5 4.7 4.7 4.7 4.6 4.6 4.5 4.6 5.0 4.9 4.8 4.9 4.7 4.5 4.6 5.4 5.2 5.2 5.1 5.0 4.7 4.7 5.4 5.3 5.3 5.2 5.0 4.7 4.7 5.9 5.8 5.7 5.6 5.4 4.8 5.1 2003 2004 2005 2006 2007 2008 2009 Total
1999
2000
2001
1998
7.1
7.3
6.7
1999
6.4
6.1
2000 . . . . . . . .
5.9
2001
2002
2003
Purchase year
2004
2005
2006
2007
2008
Total
7.1
6.8
6.2
Table A3.2: Nominal median annual gross rental return a year by purchase and sale years units/apartments (Base case)
Sale Year 2002 6.3 5.9 5.6 5.2 . . . . . . . 5.7 . . 5.3 . . . . . . 5.2 . . . 4.7 4.8 4.9 4.8 4.7 4.7 . . . . 5.1 5.1 5.0 5.0 5.4 5.4 5.2 5.3 5.0 4.8 4.5 4.8 4.7 . . . 5.0 5.6 5.6 5.6 5.5 6.0 5.9 5.9 5.7 2003 2004 2005 2006 2007 5.5 5.3 5.1 4.9 4.6 4.5 4.5 4.6 4.6 . . 4.7 2008 5.1 5.1 4.9 4.7 4.5 4.4 4.5 4.5 4.6 4.3 . 4.6 2009 5.3 5.2 5.1 4.9 4.6 4.6 4.5 4.5 4.6 4.4 4.0 4.7 Total 6.3 5.7 5.3 5.0 4.7 4.6 4.5 4.5 4.6 4.3 4.0 5.1
1999
2000
2001
1998
7.5
7.3
6.7
1999
6.6
6.3
2000 . . . . . . . .
5.7
2001
2002
2003
Purchase year
2004
2005
2006
2007
2008
Total
7.5
7.0
6.3
Table A3.3: Nominal median annual capital return a year by purchase and sale years houses (Base case)
Sale Year 2002 13.6 11.7 11.7 12.2 10.3 7.9 5.4 5.8 7.9 12.0 10.0 8.9 10.1 14.4 16.9 22.6 . . . . . . . 15.6 14.8 11.4 8.8 7.3 8.6 8.3 . . . . . . 8.9 7.3 . . . . . 13.1 7.2 . . . . 19.0 11.5 8.1 . . . 8.6 8.7 7.9 6.7 . . 7.0 4.1 5.8 6.6 5.7 . 9.7 4.9 3.8 5.8 5.9 5.3 19.7 9.7 6.8 6.0 7.4 7.4 6.8 15.2 11.5 9.5 8.0 9.0 8.6 7.6 15.4 12.5 10.3 9.3 10.0 9.5 8.7 13.7 11.8 10.1 9.4 9.9 9.2 8.6 13.4 11.7 10.3 9.5 9.9 9.6 8.6 2003 2004 2005 2006 2007 2008 2009 Total
1999
2000
2001
1998
16.6
11.7
13.5
1999
15.1
14.1
2000 . . . . . . . .
21.9
2001
2002
2003
Purchase year
2004
2005
2006
2007
2008
Total
16.6
12.9
15.2
Table A3.4: Nominal median annual capital return a year by purchase and sale years units/apartments (Base case)
Sale Year 2002 13.2 12.9 16.3 23.2 . . . . . . . 15.2 . . 12.5 . . . . . . . . 9.2 . 9.3 15.2 6.1 4.5 3.4 6.1 . . . . 6.9 12.1 8.5 5.9 13.2 9.9 8.5 7.2 5.0 3.8 3.1 4.0 9.6 . . . 5.4 12.0 9.6 8.4 7.4 12.2 10.1 9.2 8.0 2003 2004 2005 2006 2007 8.7 8.3 7.9 6.1 4.8 4.3 5.3 7.9 17.8 . . 6.5 2008 8.9 8.1 8.4 6.6 5.6 5.3 6.5 8.2 10.3 13.6 . 7.2 2009 8.3 7.8 7.4 6.2 4.9 5.1 6.2 7.6 9.1 8.6 14.4 6.7 Total 10.6 9.8 9.9 7.5 5.3 4.6 5.7 7.9 11.1 10.3 14.4 8.3
37
1999
2000
2001
1998
16.7
11.6
12.8
1999
17.7
13.2
2000 . . . . . . . .
25.5
2001
2002
2003
Purchase year
2004
2005
2006
2007
2008
Total
16.7
13.6
15.0
Table A3.5: Average value of cash flows25

Units 211,241 179,555 8,523 12,633 60 343 1,763 1,170 1,390 4,726 14,454 -3,597 281,498 70,257 13,903 8,623 69,740 171,868 9,812 19,263 97,985 329,322 -4,282 15,829 5,357 1,471 1,332 2,005 391 159 13,368 9,664 196,636 231,337 All
Houses
Average Purchase Price
245,059
Average Loan
208,300
Average Stamp Duty
10,443
Average Gross Rent
13,870
Average Land Tax
227
Average Building Insurance
423
Average Maintenance
2,169
Average LGA Rates
1,442
Average Management Fees
1,526
Average Operating Costs
5,787
Average Loan Repayments
16,768
Average Net Rent
-4,750
Average Sale Price
361,979
Average Capital Gain
116,919
Average Capital Gain Tax
22,923
Average Selling Fees
10,623
Sample Size
102,128
25 Cash
flows that accrue on a recurrent basis (e.g. gross rent) are measured on an annual basis
Appendix 4: Supplementary tables detailed IRR for each hypothetical investor
The following tables present detailed cash flow by holding period IRR calculations for the three hypothetical investors. Houses and flats are presented separately, as are the IRRs by purchase year for individual investors.
IRR tables Individual Investor

Sale Year 2002 30% 25% 23% 24% 19% 12% 8% 8% 10% 14% . . 16% 9% . 14% 9% 11% 4% -2% 12% 5% 5% 9% 14% 6% -2% 18% 30% 31% 28% . . . . . . . 30% 28% 21% 15% . . . . 12% . . . . . . . . 19% . . . -2% 8% . . -6% -3% 5% 9% . 1% -1% -1% 7% 8% 21% 12% 8% 8% 13% 13% 26% 21% 18% 15% 18% 17% 15% 12% 31% 26% 21% 19% 21% 19% 18% 29% 25% 21% 20% 21% 19% 18% 29% 26% 23% 21% 21% 20% 19% 2003 2004 2005 2006 2007 2008 2009 Average
Table A4.1: IRR results by purchase and sale year houses
1999
2000
2001
1998
21%
21%
28%
1999
18%
25%
2000 . . . . . . . .
30%
2001
2002
2003
Purchase Year
2004
2005
2006
2007
2008
All
21%
20%
27%
39
Table A4.2: IRR results by purchase and sale year units/apartments

Sale Year 2002 29% 23% 20% 20% 13% 7% 3% 6% 10% 14% 9% 11% 15% 26% 30% 32% . . . . . . . 29% 23% 17% 11% 8% 11% 12% . . . . . . 11% 11% . . . . . 12% 7% . . . . 16% 12% 13% . . . 2% 8% 11% 12% . . -2% -4% 4% 10% 10% . 3% -3% -3% 4% 7% 8% 14% 3% 2% 2% 7% 10% 8% 18% 14% 10% 8% 11% 12% 12% 27% 20% 17% 15% 16% 17% 15% 25% 21% 17% 16% 17% 17% 16% 27% 23% 20% 18% 19% 19% 17% 2003 2004 2005 2006 2007 2008 2009 Average
1999
2000
2001
1998
23%
22%
28%
1999
25%
23%
2000 . . . . . . . .
38%
2001
2002
2003
Purchase Year
2004
2005
2006
2007
2008
All
23%
23%
28%
Table A4.3: Median cash flow figures by holding period houses

Year 5 91,884 -1,859 -1,625 -1,274 -1,000 -729 -804 -426 -906 -480 -795 -1,088 -1,317 -1,300 -1,111 -849 -950 -536 -1,627 121,857 107,176 141,219 -1,105 -883 -1,007 -563 164,717 -867 -999 -592 Year 6 Year 7 Year 8 Year 9 Year 10 186,350 -911 -509 Year 11 204,379 -344 Year 12 194,242 Cash flow at end 55,284 63,512 76,905 91,884 107,176 121,857 141,219 164,717 186,350 204,379 194,242 88,795 IRR % 17.28% 16.92% 18.52% 17.91% 17.53% 17.86% 19.27% 19.64% 19.91% 18.84% 18.73% 18.27%
Holding Cash flow Period start -
Year 1
Year 2
Year 3
Year 4
-42,228
-2,151
55,284
-40,810
-2,063
-2,126
63,512
-39,760
-1,909
-1,965
-1,999
76,905
-39,550
-1,880
-1,925
-1,974
-1,998
-37,681
-1,707
-1,749
-1,793
-1,826
-34,930
-1,478
-1,495
-1,537
-1,584
-31,990
-1,141
-1,132
-1,158
-1,218
-29,470
-909
-894
-891
-933
-26,950
-641
-658
-649
-664
10
-27,790
-733
-731
-724
-741
11 -
-22,435
-333
-373
-360
-399
All
-38,500
-1,760
-1,336
-528
Table A4.4: Median cash flow figures by holding period units

Year 5 70,037 -1,784 -1,725 -1,489 -1,196 -809 -660 -455 -526 -600 -577 -615 -562 -478 156,664 -705 -755 -781 -724 -622 153,347 153,347 156,664 69,342 -861 -906 -923 -880 135,585 135,585 -1,235 -1,238 -1,172 118,163 118,163 -1,495 -1,475 100,852 100,852 14.75% 16.25% 17.41% 17.47% 17.48% 14.83% -1,715 86,763 86,763 12.98% 78,434 78,434 12.16% 70,037 12.67% 61,814 14.85% 52,801 15.21% 46,336 21.25% Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Cash flow at end IRR %
Year 1
Year 2
Year 3
Year 4
-32,935
-1,561
46,336
-34,510
-1,626
-1,627
52,801
-35,350
-1,703
-1,705
-1,701
61,814
-36,610
-1,811
-1,799
-1,791
-1,777
-37,030
-1,826
-1,815
-1,825
-1,817
-36,610
-1,705
-1,697
-1,700
-1,712
-34,510
-1,433
-1,449
-1,429
-1,464
-30,310
-1,133
-1,124
-1,135
-1,148
-26,110
-767
-760
-760
-773
10
-24,010
-649
-662
-634
-618
11 -
-22,855
-508
-466
-427
-426
All
-34,510
-1,600
-1,299
-743
IRR tables Company
Table A4.5: Median cash flow figures by holding period houses (company)
Year 5 83,506 -5,433 -4,938 -4,239 -3,680 -3,183 -3,309 -2,405 -3,617 -2,685 -3,469 -4,013 -4,215 -3,714 -3,953 -2,982 -4,492 -4,655 -5,105 110,527 97,271 128,160 -4,388 -3,954 -4,155 -3,184 149,311 -4,081 -4,352 -3,257 168,935 -4,416 -3,315 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 185,688 -3,240 Year 12 176,086 Cash flow at end 50,179 57,695 69,824 83,506 97,271 110,527 128,160 149,311 168,935 185,688 176,086 80,642 IRR % 8.89% 9.37% 11.44% 11.11% 11.04% 11.84% 13.74% 14.35% 15.04% 13.90% 14.25% 11.84%
41
Year 1
Year 2
Year 3
Year 4
-42,228
-5,429
50,179
-40,810
-5,248
-5,557
57,695
-39,760
-4,931
-5,204
-5,467
69,824
-39,550
-4,844
-5,112
-5,370
-5,550
-37,681
-4,500
-4,748
-5,018
-5,241
-34,930
-3,942
-4,176
-4,427
-4,692
-31,990
-3,239
-3,432
-3,670
-3,953
-29,470
-2,780
-2,917
-3,115
-3,371
-26,950
-2,295
-2,489
-2,622
-2,813
10
-27,790
-2,464
-2,681
-2,772
-3,009
11 -
-22,435
-1,541
-1,747
-1,957
-2,190
All
-38,500
-4,599
-3,864
-2,320
Table A4.6: Median cash flow figures by holding period units (company)
Year 5 63,640 -5,069 -4,945 -4,593 -3,963 -3,017 -2,821 -2,360 -2,588 -2,861 -3,011 -2,938 -3,020 -3,024 142,526 -3,056 -3,200 -3,363 -3,463 -3,409 139,483 139,483 142,526 63,104 -3,292 -3,532 -3,728 -3,788 122,778 122,778 -4,187 -4,334 -4,362 107,260 107,260 -4,701 -4,808 91,750 91,750 9.41% 11.10% 12.37% 12.63% 12.72% 8.76% -5,043 78,730 78,730 7.54% 71,099 71,099 6.26% 63,640 6.59% 56,347 8.31% 48,146 7.70% 42,133 12.94% Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Cash flow at end IRR %
Year 1
Year 2
Year 3
Year 4
-32,935
-4,081
42,133
-34,510
-4,205
-4,406
48,146
-35,350
-4,418
-4,547
-4,703
56,347
-36,610
-4,616
-4,721
-4,837
-4,961
-37,030
-4,663
-4,763
-4,879
-4,980
-36,610
-4,436
-4,522
-4,684
-4,824
-34,510
-3,906
-4,079
-4,165
-4,387
-30,310
-3,240
-3,363
-3,541
-3,693
-26,110
-2,433
-2,606
-2,704
-2,850
10
-24,010
-2,235
-2,348
-2,453
-2,586
11
-22,855
-1,805
-1,927
-2,061
-2,232
All
-34,510
-4,192
-3,689
-2,636
-367
IRR tables Superannuation Fund
Table A4.7: Median cash flow figures by holding period houses (superannuation fund)
Year 5 278,414 1,972 2,030 2,206 2,320 2,475 2,421 2,693 2,059 2,385 2,118 1,920 1,608 1,732 1,622 2,035 1,873 1,662 1,812 301,359 291,936 313,198 1,378 1,414 1,190 1,733 326,865 1,259 945 1,464 336,278 843 1,505 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 364,722 1,698 Year 12 345,271 Cash flow at end 253,150 256,248 263,207 278,414 291,936 301,359 313,198 326,865 336,278 364,722 345,271 275,898 IRR % 5.55% 6.11% 6.85% 6.98% 7.19% 7.64% 8.58% 9.07% 9.50% 9.15% 9.35% 7.27%
Year 1
Year 2
Year 3
Year 4
-230,715
2,660
253,150
-223,560
2,764
2,465
256,248
-218,260
2,888
2,599
2,342
263,207
-217,200
2,940
2,633
2,367
2,100
-207,766
3,064
2,805
2,528
2,226
-193,880
3,154
2,897
2,605
2,305
-179,040
3,378
3,093
2,823
2,522
-166,320
3,525
3,277
2,947
2,661
-153,600
3,750
3,409
3,134
2,816
10
-157,840
3,680
3,264
2,988
2,735
11
-130,810
3,862
3,667
3,324
3,066
All
-211,900
2,961
3,051
2,659
1,495
Table A4.8: Median cash flow figures by holding period units/apartments (superannuation fund)
Year 5 246,715 2,080 2,142 2,213 2,296 2,313 2,398 2,486 2,265 2,046 1,810 1,594 1,499 1,548 300,873 2,115 1,811 1,533 1,484 1,577 298,618 2,076 1,849 1,690 1,635 288,335 288,335 298,618 300,873 244,739 2,086 1,887 1,834 290,838 290,838 2,034 1,939 284,850 284,850 6.42% 7.41% 8.20% 8.48% 8.69% 5.93% 2,045 271,671 271,671 5.46% 260,771 260,771 5.07% 246,715 5.18% 232,288 5.72% 220,970 5.65% 213,042 6.42% Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Cash flow at end IRR %
Year 1
Year 2
Year 3
Year 4
-183,810
2,507
213,042
-191,760
2,613
2,418
220,970
-196,000
2,611
2,436
2,251
232,288
-202,360
2,666
2,487
2,346
2,190
-204,480
2,655
2,528
2,356
2,189
-202,360
2,818
2,700
2,525
2,306
-191,760
2,936
2,837
2,672
2,428
-170,560
3,086
2,939
2,769
2,518
-149,360
3,216
3,026
2,793
2,568
10
-138,760
3,271
3,064
2,864
2,672
11
-132,930
3,481
3,206
3,019
2,703
All
-191,760
2,715
2,918
2,523
1,830
IRR tables Company with NRAS
Table A4.9: Median cash flow figures by holding period houses (company): with NRAS
Year 5 90,426 1,454 2,019 2,646 3,262 3,777 3,586 4,640 3,508 3,284 4,325 2,946 2,386 2,208 2,715 3,238 2,947 4,026 1,809 117,296 104,125 134,939 2,516 2,954 2,687 3,785 156,079 2,816 2,462 3,640 Year 6 Year 7 Year 8 Year 9 Year 10 175,529 2,367 3,550 Year 11 192,213 3,600 Year 12 182,727 Cash flow at end 57,174 64,667 76,733 90,426 104,125 117,296 134,939 156,079 175,529 192,213 182,727 87,528 IRR % 25.74% 24.28% 23.86% 22.12% 22.26% 23.90% 26.44% 27.60% 28.93% 27.37% 30.33% 24.44%
43
Year 1
Year 2
Year 3
Year 4
-42,228
1,525
57,174
-40,810
1,729
1,382
64,667
-39,760
2,063
1,754
1,477
76,733
-39,550
2,152
1,855
1,579
1,363
-37,681
2,514
2,219
1,930
1,692
-34,930
3,097
2,851
2,582
2,308
-31,990
3,783
3,602
3,305
2,961
-29,470
4,244
4,058
3,881
3,587
-26,950
4,686
4,509
4,347
4,108
10
-27,790
4,577
4,347
4,133
3,938
11 -
-22,435
5,589
5,213
5,099
4,866
All
-38,500
2,407
3,153
2,514
Table A4.10: Median cash flow figures by holding period units (company): with NRAS
Year 5 70,696 1,864 1,961 2,383 3,001 3,944 4,245 4,758 4,546 4,150 4,048 4,065 3,942 3,909 149,293 4,011 3,743 3,544 3,446 3,556 146,085 146,085 149,293 70,070 3,666 3,406 3,234 3,147 129,788 129,788 2,775 2,609 2,510 113,866 113,866 2,162 2,075 98,649 98,649 22.32% 24.57% 27.95% 28.09% 29.69% 23.11% 1,841 85,659 85,659 20.21% 78,159 78,159 18.90% 70,696 19.65% 63,232 22.67% 55,146 25.06% 49,342 34.54% Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Cash flow at end IRR %
Year 1
Year 2
Year 3
Year 4
-32,935
3,071
49,342
-34,510
2,895
2,679
55,146
-35,350
2,718
2,543
2,370
63,232
-36,610
2,498
2,356
2,197
2,028
-37,030
2,442
2,308
2,146
2,018
-36,610
2,645
2,477
2,306
2,147
-34,510
3,144
3,006
2,809
2,564
-30,310
3,866
3,709
3,511
3,273
-26,110
4,678
4,493
4,405
4,209
10
-24,010
4,909
4,737
4,643
4,462
11 759
-22,855
5,351
5,161
5,020
4,890
All
-34,510
2,913
3,404
2,657
IRR tables Superannuation fund with NRAS
Table A4.11: Median cash flow figures by holding period houses (superannuation fund): with NRAS
Year 5 284,653 8,417 8,526 8,711 8,802 9,031 8,991 9,285 8,606 9,021 8,629 8,394 7,990 8,194 8,041 8,549 8,339 8,039 8,240 307,708 298,143 319,623 7,734 7,865 7,648 8,187 333,380 7,613 7,277 7,918 342,531 7,158 7,836 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 371,277 7,870 Year 12 351,489 Cash flow at end 259,679 262,679 269,700 284,653 298,143 307,708 319,623 333,380 342,531 371,277 351,489 282,320 IRR % 8.74% 9.05% 9.57% 9.45% 9.73% 10.40% 11.56% 12.18% 12.80% 12.39% 12.83% 10.04%
Year 1
Year 2
Year 3
Year 4
-230,715
9,273
259,679
-223,560
9,369
9,017
262,679
-218,260
9,518
9,168
8,852
269,700
-217,200
9,537
9,202
8,877
8,562
-207,766
9,673
9,363
9,048
8,724
-193,880
9,780
9,485
9,188
8,860
-179,040
9,991
9,692
9,385
9,058
-166,320
10,128
9,844
9,529
9,212
-153,600
10,356
10,000
9,699
9,379
10
-157,840
10,323
9,927
9,627
9,334
11
-130,810
10,553
10,206
9,954
9,560
All
-211,900
9,600
9,605
9,195
7,954
Table A4.12: Median cash flow figures by holding period units (superannuation fund): with NRAS
Year 5 253,346 8,644 8,730 8,796 8,929 9,046 9,096 9,240 5,930 8,934 8,553 8,349 8,130 8,025 8,025 307,253 8,771 8,448 8,203 8,054 8,046 304,678 8,782 8,557 8,308 8,188 294,305 294,305 304,678 307,253 251,130 8,678 8,474 8,381 297,153 297,153 8,622 8,514 291,068 291,068 9.50% 10.65% 11.74% 11.97% 12.26% 9.07% 8,588 277,816 277,816 8.48% 267,239 267,239 8.07% 253,346 8.09% 238,953 8.76% 227,564 9.04% 219,760 10.38% Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Cash flow at end IRR %
Year 1
Year 2
Year 3
Year 4
-183,810
9,298
219,760
-191,760
9,382
9,142
227,564
-196,000
9,338
9,121
8,916
238,953
-202,360
9,370
9,170
8,998
8,800
-204,480
9,332
9,189
9,010
8,815
-202,360
9,448
9,310
9,130
8,937
-191,760
9,588
9,416
9,251
9,018
-170,560
9,755
9,544
9,379
9,165
-149,360
9,939
9,736
9,521
9,284
10
-138,760
10,011
9,824
9,583
9,355
11
-132,930
10,175
9,874
9,696
9,451
All
-191,760
9,428
9,502
9,139
8,504
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Human Services Victoria - Investment Returns Rental Housing

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Human Services Victoria - Investment Returns Rental Housing

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Investment returns from rental housing in Melbourne, 19982009

Department of Human Services Victoria

Investment returns from rental housing in Melbourne, 19982009

iv Investment returns from rental housing in Melbourne, 19982009

Rates of return for Melbournes rental housing, 19982009

Analysis IRR for hypothetical rental investors Melbourne 19982009

Closing the rental gaps NRAS

Conclusion Some further considerations

vi Investment returns from rental housing in Melbourne, 19982009

viii Investment returns from rental housing in Melbourne, 19982009

x Investment returns from rental housing in Melbourne, 19982009

2 Investment returns from rental housing in Melbourne, 19982009

Source: Australian Bureau of Statistics, 6416.0

4 Investment returns from rental housing in Melbourne, 19982009

Table 1: Volume of sales, metropolitan Melbourne, 19982009

Chart 2: Investment in rental housing, Victoria, 19982009

Per cent all housing finance

6 Investment returns from rental housing in Melbourne, 19982009

Chart 3: Standard variable home loan interest rate, 19982009

Melbournes rental market, 19982009

8 Investment returns from rental housing in Melbourne, 19982009

Chart 5: Annual rate of change in estimated resident population, Victoria 19912009.

10 Investment returns from rental housing in Melbourne, 19982009

600 over 0 and

Source: Office of Housing, unpublished

Chart 8: Total active bonds metropolitan Melbourne, 19992009

Number of active bonds

14,000 12,000 10,000 8,000 6,000 4,000 2,000 0

12 Investment returns from rental housing in Melbourne, 19982009

Barriers to institutional Rental Investment

14 Investment returns from rental housing in Melbourne, 19982009

The National Rental Affordability Scheme

Rates of return for Melbournes rental housing, 19982009

The method the internal rate of return

The model RMIT IRR

16 Investment returns from rental housing in Melbourne, 19982009

The sample matched sales and rentals

Representativeness, Exclusions and outliers

18 Investment returns from rental housing in Melbourne, 19982009

Analysis IRR for hypothetical rental investors Melbourne 19982009

Key Findings individual investors

20 Investment returns from rental housing in Melbourne, 19982009

Rent Decile 1 2 3 4 5 6 7 8 9 10 Mean

Key Findings company investors

Superannuation fund Investors

Key Findings superannuation fund investors

22 Investment returns from rental housing in Melbourne, 19982009

Closing the rental gaps NRAS

24 Investment returns from rental housing in Melbourne, 19982009

A company investor with NRAS

Key Findings company investor with NRAS

A superannuation fund investor with NRAS

Key Findings superannuation fund investor with NRAS

Conclusion Some further considerations

Continuing the analysis

26 Investment returns from rental housing in Melbourne, 19982009

Appendix 1: Constructing the sample

28 Investment returns from rental housing in Melbourne, 19982009

Appendix 2: Structure of the IRR model

The Introduction of Taxation On Rental Income

= the marginal income tax rate of the landlord, then

The Introduction of Debt

30 Investment returns from rental housing in Melbourne, 19982009