There are fewer less-understood markets than the residential property market. This is strange because the rental market is not especially complicated — rental prices are almost solely determined by the number of vacant rental properties — although business journalists are commonly thinking of other excuses or reasons as to why rents go up or down.

A classic example was in yesterday’s Australian Financial Review where Lisa Carapiet noted that “rental (price) growth across Australia was subdued during the September quarter as home-buyers flocked to the market before the federal government’s first-home-owner’s boost was halved.” On other occasions, so-called property experts suggest that higher interest rates will lead to higher rental prices as landlords seek to maintain existing rental yields.

Both theories are wrong.

The problem with the first-home-owner argument is that those first-home buyers who are leaving the rental market are reasonably likely to be buying a property that is currently being rented anyway (unless they are purchasing a newly constructed property). What that often means is that they will often buy from an investor a property that  is currently tenanted to a first-home buyer (alternatively, they are buying from another owner-occupier who has to then find another property themselves). When the investor evicts their current tenants so the first-home buyer can move in, those tenants are put back in the rental pool, so the supply-and-demand equation remains unaltered. (If anything, the movement is actually likely to lead to an increase in rentals as landlords often take the opportunity to increase rentals to current market rates when tenants depart).

Similarly, the “higher-interest-rates-leads-to-higher-rent argument” is equally fallacious. Landlords are not generally a charitable group. They will not seek a specific yield and should interest rates go down, lower the rental cost to tenants. Rather, landlords (or actually property managers on behalf of landlords) will charge as much as possible to tenants without causing the property to be vacant for too long.

If property managers see 20 potential renters attending rental inspections, they will start increasing rental rates across the board until applications dry up (regardless of what interest rates are). Most property managers have a rent roll of several hundred properties (at least) and should be able to accurately gauge demand. For example, Melbourne rental rates have increased by upwards of 50% in some areas in recent years while interest rates have slumped. That is because immigration continued without satisfactory construction of new dwellings.

In reality, the main factor that holds down rents is an increased supply of rentable properties (demand for rental properties is generally pretty steady, unless there is a drastic change in economic activity). While the first-home-owner’s boost wouldn’t have a real effect on rental prices, there is a government policy that is having an effect — that is, the recent changes to foreign investment rules.

Until March this year, property developers were only able to sell half off a new development off-the-plan to overseas (often South-East Asian) buyers. Selling to overseas buyers was perfected by large developments, with those buyers appearing less cynical than locals. The new changes allow developers to sell 100% of a new project off-the-plan to overseas-based investors so long as the project is marketed in Australia as well. The rule change will make it easier for developers to start new projects and increase margins. It is also a good thing for the rental market because overseas investors will almost always rent the property rather than move in themselves.

The effect of the law change is already occurring. Melbourne’s largest apartment builder, Central Equity, recently successfully applied to expand its proposed apartment development on current Age site on Spencer Street to more than 800 apartments.

The law change may not have been intended as a means of keeping rents down (it more likely came about following lobbying by politically savvy and high-donating developers) but it will most likely have that (positive) effect. Well, until overseas buyers finally realise they are over-paying for properties.