Australian property investors need to accept that policy risk has increased substantially, and that this is a permanent shift. Tighter tenancy laws and higher taxes erode returns, and the only way to offset that is to pursue higher returns through a more proactive investment approach.
Melbourne’s 15-year property reality check
According to Cotality’s Daily Price Index, which began just over 15 years ago, Melbourne’s median house price has increased by approximately 1% p.a. above inflation. That is not a compelling return. Long-term property investors in Melbourne have good reason to feel underwhelmed.
Borrowing to invest in property only makes sense if after-tax capital growth more than offsets the cumulative cost of holding the asset over time. Most investors accept negative cash flow willingly – losing $1 in holding costs is tolerable if it produces $10 in capital growth. The problem most Melbourne investors are facing is that holding costs have risen materially, investor control has been eroded, and capital growth has not compensated for either.
Holding costs have increased significantly, particularly over the last 5to 10 years. Insurance and council rates have risen significantly, Victoria has introduced land tax increases and a range of additional property taxes, and average interest rates over the past 3 years have been more than double what they were in the preceding decade. Each of these factors compounds the others.
Alongside rising holding costs, the Victorian Government has introduced over 130 individual tenancy law reforms since 2018. Many of these reforms are reasonable. Some, however, significantly reduce the control that investors have over what is typically one of their most valuable assets, and control is one of the primary reasons investors choose property in the first place. These reforms also add to holding costs directly, through mandated property improvements such as insulation upgrades and compliance checks.
Every tenant deserves to live in a safe and comfortable home, and most property investors are genuinely willing to provide that. However, some of the specific rules produce outcomes that are difficult to justify. In Victoria, a property that does not meet minimum rental standards cannot be advertised for rent. That restriction is, in many cases, counterproductive. Where compliance issues are minor, an investor should be able to advertise the property and enter into a conditional agreement – one where the tenancy commences once the property meets the required standards. To illustrate how disproportionate the current rules can be: a property may fail minimum rental standards because a blind is missing a cord cleat – a small plastic clip that secures a blind cord to the wall. That is a repair that takes minutes to complete. Preventing the property from being listed until it is fixed serves no practical purpose and simply costs the investor time and money.
These are not isolated examples. A pattern of similar rules has produced a range of unintended consequences. None of them in isolation are a big deal but collectively reduce landlord control and make investing less attractive.
Finally, investors may soon face an additional headwind. The upcoming federal budget is expected to include measures that could increase the rate of capital gains tax – the one return that was supposed to justify carrying all the above.
Is flat growth the answer to housing affordability?
The Victorian government’s position is straightforward: slower property price growth, or even outright price falls, improve affordability for those who do not yet own a home. On that logic, the Government is unlikely to be troubled by 15 years of subdued Melbourne price growth – it may well regard it as a feature rather than a flaw.
The UK offers a useful reference point. Changes to tenancy laws and property taxation there have demonstrably cooled price growth and, in some cases, reduced values. That is the policy risk Melbourne investors face.
If current governments continue pursuing policies that prioritise affordability over investor returns, and there is little reason to expect otherwise, then subdued or negative capital growth is not just a historical observation. It is a plausible base case that investors need to factor into their decision-making.
Victoria today, everywhere tomorrow
In August 2023, National Cabinet agreed to a nine-point plan to harmonise renter protections across all states and territories. The commitments cover abolishing no-grounds evictions, limiting rent increases to once per year, banning rent bidding, capping break-lease fees, phasing in minimum property standards, standardising rental applications, and more.
Victoria is the most advanced jurisdiction and has already implemented most of these reforms. New South Wales is not far behind. Queensland, South Australia, and Western Australia are mid-pack. The ACT has long operated in a high-regulation environment. Tasmania and the Northern Territory lag the furthest.
Regardless of the current situation, every state and territory will eventually need to catch up to where Victoria is today. For property investors, that is not a risk confined to Melbourne – it is a national one.
Other holding costs such as insurance, council rates, and interest rates, are broadly consistent across all states and territories. Every Australian property investor has faced much the same increases on those fronts.
That raises an important question. If tenancy laws and general holding costs are converging nationally, why has Melbourne underperformed so materially on capital growth? Land tax may be part of the answer, but it is unlikely to be the primary driver.
The more significant factor, in my view, is overall negative sentiment. Victoria has had genuine positive stories over the past decade (such as population growth), but they have been consistently overshadowed by a catalogue of negatives: poor fiscal management, rising state debt, new and expanding taxes, infrastructure projects plagued by cost blowouts, costly infrastructure projects that failed to meet their business cases, corruption, some of the most prolonged Covid lockdowns in the world and the list goes on.
Not all these factors directly affect property values, but collectively they shape how investors perceive and feel about a location, and sentiment is a powerful force in any asset market.
The encouraging counterpoint is that sentiment can shift quickly, and when it does, it tends to drive price growth – we have witnessed that in Queensland. That potential re-rating is very much still on the table for Melbourne.
The one bright spot Melbourne investors can count on
Rental bond data and analysis from the REIV confirms that investors have been leaving Victoria, an entirely predictable response to years of underwhelming capital growth.
The longer negative sentiment persists, the more this investor exodus will translate into tightening rental supply. The likely result is very low vacancy rates and above-average rental growth, perhaps the only silver lining for Melbourne property investors in the near term. This is precisely the pattern that played out in the UK following its own period of investor-unfriendly policy and subdued price growth.
The risk-reward equation has permanently shifted
I think the investment landscape for Australian property investors has shifted materially. Policy risk is now a permanent feature of the environment, not a temporary headwind. Tighter tenancy laws reduce investor control and increase investment risk. Property taxes have moved in one direction only, and there is no reason to expect that to change. Investors should assume a higher ongoing taxation drag on property returns than they have experienced historically.
The political dimension compounds this. Lower property prices are attractive to left-leaning governments on affordability grounds, even if it creates its own political problem, given that existing owners, who vote, are not well served by falling values.
The net result is that the risk-reward proposition for direct property investment has changed materially compared to when I started this business almost 25 years ago. That is not an argument against investing in property. It is an argument for going in with realistic expectations. Property today carries greater risk than it did a decade or two ago, and investors should be targeting higher returns to reflect that.
Property may no longer be “set and forget”
Over the past 20 years, the median house price across Melbourne, Sydney and Brisbane has grown at just under 6% p.a., on average. In the preceding 20-year period, that figure was almost 8.5% p.a. The set-and-forget approach that served the previous generation of property investors may not deliver the same results going forward.
As such, last year, I wrote a blog about value-add investing, covering how to select a property where you can actively improve the asset through renovations that lift its value, marketability, capital growth prospects, and rental income.
Beyond that, properties with some element of uniqueness or alternative use tend to outperform over time.
Uniqueness might mean water views or a position in a tightly held, highly sought-after location.
Alternative use might mean a family home that could also be subdivided into a multi-dwelling site. The point is not necessarily to pursue those alternative uses, but to ensure the asset’s performance is not dependent on a single outcome. That breadth reduces risk and improves the range of possible returns.
Given the headwinds I have outlined, property investors need to be more deliberate and proactive than in previous decades. A value-add approach, combined with assets that offer uniqueness or optionality, gives investors the best chance of generating returns that are high enough to offset greater policy risk, higher holding costs, and a heavier tax drag, and still deliver an acceptable outcome.
Diversification is now non-negotiable
Beyond property strategy enhancements, investment diversification is no longer optional, it is imperative.
Investing within a single state was once largely a matter of personal preference. Today, given how clearly sentiment, rather than fundamentals, can suppress returns for years at a time, geographic diversification has become a genuine necessity.
Any investor planning to own more than one property should give serious consideration to spreading those assets across different states. In my own situation, had I not held property outside Victoria, my investment property portfolio would have delivered materially worse returns over the past decade.
The same logic applies across asset classes. Every investor, where possible and appropriate, should hold exposure to both major growth asset classes, property, and shares. The global share (MSCI) index has returned between 9.5% and 10% p.a. over the last 20 years. Melbourne property investors who also held international shares would have had at least a meaningful portion of their portfolio performing strongly through a period when local property largely disappointed. That contrast makes the case for asset class diversification as clearly as any theoretical argument could.
What should investors do differently?
Given everything outlined above, here is how I think investors should approach property investment in the current environment:
- Target higher returns. Accept that the risk profile of property has increased and set your return expectations accordingly. If the numbers do not stack up at a higher hurdle rate, the investment is not compelling enough.
- Employ a value-add strategy. Do not buy assets that rely solely on market growth to deliver returns. Select properties where you can actively improve the asset, lift its rental income, and enhance its capital growth prospects through your own effort and judgement.
- Prioritise assets with uniqueness or optionality. Properties in tightly held locations, or those with alternative use potential, are more resilient and tend to outperform over time. Avoid assets that are entirely dependent on a single outcome.
- Diversify deliberately. Spread property investments across states rather than concentrating in one jurisdiction. And ensure your overall investment portfolio includes exposure to both property and shares.
- Stress-test your holding costs. Model your investment assuming higher land tax, higher insurance, higher compliance costs, and potentially higher capital gains tax. If the investment still makes sense under those assumptions, it is worth pursuing.
Melbourne will recover, but the old playbook may not work
Investment markets routinely test investor patience, and Melbourne property investors have had more than their share of that over the past 15 years. But Melbourne will bounce back. And precisely because growth has been subdued for so long, that recovery is likely to be significant when it arrives.
What remains uncertain is the timing. What is not uncertain is that fundamentally sound, investment-grade property assets will eventually deliver the returns investors are seeking. Melbourne is not a broken market.
For investors who hold property outside Melbourne, the lesson is not to underestimate policy risk. It is a real and permanent feature of the Australian property investment landscape, not a temporary anomaly, and it needs to be accommodated explicitly in your strategy.
The rules of property investment in Australia have changed. Investors who recognise that and adjust accordingly will be better positioned than those who assume the conditions of the past two decades will simply reassert themselves.
