There is a simple relationship between property growth rate and net rental return. Assuming R is investor’s expected return from investing in properties, r is rental income (net of costs) and G is property annual growth rate:
R = Expected Return
r = Rental Income
G = Growth Rate
Then the simple relationship can be like this (note this is only true to some extent and when you look at things from long term perspective):
R = r + G
For example, if investors expect property annual growth rate of 5% and net rental of 3%, their expected return from investing in properties is 8% = 5% + 3%.
R is generally a constant for a certain asset under same interest rate environment.
In DCF (discounted cash flow) analysis, R is the discount rate to be used where Property’s market value MV = net rental in year1/(1+R) + net return in year2/(1+R)^2 + …….., so the higher the R is, the lower your property’s market value will be, and as mentioned above, R generally equals to government bond rate + risk premiums. By now we should understand why an interest rate hike normally has big impacts on property values. The impacts are two folds:
Net rental income r will drop due to higher mortgage payments;
More significantly, an interest rate increase will generally push up government bond rate, end up with higher discounting rate R, then lower present value of future cash flows.
Back to Alan’s article (寬逆周期措施,會否達致豪宅前十年的結果?當大批本來租緊樓的人上車,放棄租住的物業,會否令到大批物業空置,迫於無奈降低租金?而租金持續下降後,會否令物業價值更加下降,形成惡性循環?), I think buying or renting will not change the overall vacancy ratio (need to rent if not buy), so will not have material impacts on property price. A further dropping in rental return might not be directly translated to price drop as long as ‘R = r + G’ still holds and if higher G can be expected by investors. What matters most should be still G (and R to a lesser extent).