Those who believe that property prices never fall probably don’t own an apartment in the world’s tallest free standing structure, Dubai’s Burj Khaflia. Bloomberg reported last week that rental prices have fallen for apartments in the building by up to 40%, less than a year after the structure opened amidst a vast water and fireworks display.

The slump in rental prices has come as 825 of the building’s 900 apartments remain unoccupied (the Burj also houses a hotel and 37 floors of offices). Not only are owners of properties in the complex not receiving rental income, they also need to pay substantial management (more commonly known in Australia as body corporate) fees. The rental slump has led to a similar drop in dwelling prices as well, with Bloomberg claiming apartment prices in the tower have dropped by as much 50% since the properties were sold off the plan prior to opening in January.

While Dubai’s collapsed luxury property market seems a world away from Australia’s burgeoning real estate sector, as recently as 2008 many experts were predicting Dubai’s property sector would continue to boom. A bit like most ‘experts’ (including the nation’s largest home lender, the CBA) who continue to claim the Australian residential property sector is not in the midst of a price bubble.

Such is the breathless enthusiasm for property price appreciation that The Age reported last Saturday “Melbourne’s property slump has continued”. The paper’s property editor, Simon Johanson, then noted houses actually increased by 0.9% during the September quarter. That was the same rate as recorded GDP growth during June.

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While property prices far outstripped growth rates since 1997, property writers claim the sector is ‘slumping’ when it managed to match income growth and exceed the general level of consumer price inflation (which the ABS claims was 0.6% during the June quarter).

More perversely, The Age also reported that “rents for houses and units in Melbourne declined 1.4% to $360 and $345 a week respectively according to Australian Property Monitors”. Rapidly appreciating prices have meant that net yields on property have slumped to around 2% — that situation was worsened in the September quarter (in Melbourne), with prices continuing to rise and rents actually falling.

It’s reminiscent of the tail end of the boom — where the dreams of exploding earnings evaporated and the intrinsic values of many companies were shown to be far removed from their market price.

Why have rents started dropping? Most likely because there is actually a surplus of rental stock rather than a shortage as alleged by the likes of the HIA. Brisbane-based property expert Michael Matusik told the Financial Review today that “rents aren’t rising and I don’t think they will do for some time … if you drive around and take a look you will find there is lots of property for rent, a lot more than the real estate industry and unfortunately the press advocate”.

Part of the reason for the sudden excess supply of dwellings in Australia has been due to the recent sharp drop in immigration levels. A rapid fall-off in the number of students (especially from India) has seen migration to Australia fall by 37% this year. The recent rise in the Australian dollar is likely to further exacerbate the downturn in new residents. It is students and recent arrivals who soak up a large proportion of rental stock.

The problem is likely to be exacerbated due to the substantial apartment construction taking place, as developers seek to profit from rising property prices.

Falling rental prices will spell disaster for the Australian property market. Already investors are required to settle for a net yield which is about a third of what they can receive in a bank savings account. However, falling rents may convince many Australian property purchasers that the hope of a future capital gain is unlikely and, like any other asset, the value of property is dependant on the cash returns it is able to generate, not forecast gains from potential income growth.

It becomes a lot harder to convince someone that their returns will increase in years to come when rental yields are dropping.