One of most poorly understood and misreported areas of property is the residential rental market. Not only do journalists tend to mindlessly follow the “expert” advice of self-interested real estate agents, but because many rental market participants are unsophisticated (even more so than property buyers), few have the knowledge or inclination to dare criticise even the most absurd of opinions. The most commonly proffered fallacy is that an increase in costs (be it higher interest rates or other charges) will lead to higher rental costs as landlords seek to maintain returns.

Even shrewd property writers such as the Financial Review’s Michelle Singer fell for that line last week, when she noted that “rising interest rates and tightening vacancy rates will force rents up well above long-term averages”. Singer also quoted Australian Property Monitors’ Matthew Bell, who claimed that “we’ve also had three successive interest rate rises and that will start to flow through to the owners’ bottom line this quarter”.

Singer was half right and half wrong. That is interest rates or other costs incurred by owners have virtually no effect on what rental rates are able to be passed on. Despite what some experts appear to think, owners do not have a target yield that needs to be met and are not able to simply flick a switch and adjust rental amounts upwards (at the end of the lease) in order to achieve that return.

Rental prices are impacted (almost entirely) by the levels of vacancy rates. Most landlords (not all) are fairly rational market participants — along with property managers (who are paid based on a percentage of the rental collected), they will seek the highest possible return for their investment (subject to other variables, including obtaining a higher quality tenant or length of lease). When more than 20 people are attending rental open-for-inspections and multiple parties submit applications, that will be a clear signal to property managers (who often manage a portfolio of upwards of 200 residences and should have a reasonably accurate understanding of market rates) that they are able to increase rentals. This was very much the case in the Melbourne and Sydney markets between 2007 and early 2009 where rental skyrocketed, in some cases, by upwards of 20% annually.

However, as unemployment crept up and additional supply came online, rentals remarkably stabilised. Instead of 30 interested parties attending rental inspections, some would have only one or two. This curbed the ability for owners to increase rental levels. Most landlords are intelligent enough to know that two weeks of vacancy will usurp a $20 per week increase in weekly rent.

Last year, APM reported that median rentals for Melbourne houses did not increase at all (in real terms, rentals actually fell). In Sydney, they rose by a meager 2.2%, Brisbane 2.9% while Adelaide recorded a 6.7% increase.

Funnily enough, those lacklustre rental rises occurred despite interest rates increasing by 75 basis points late in the year.

While it is poorly understood, the rental market has a substantial bearing on property prices, which are highly relevant to many Australians. Ultimately, the price of property bears a relationship to the rental yield that can be achieved (even if the property is being occupied by its owner). Despite there being substantial tax, lifestyle (and status) benefits to owning a property (rather than renting), eventually, if the costs to own a property are double or triple that of renting, it is a clear signal that property prices are too high. Fortune noted that in the United States, the traditional rental multiple is 18 — that is, a property should sell for 18 times its annual rental. In Melbourne, that ratio is about 24 (or 28 based on the REIV median price), and in Sydney, that ratio is approximately 20x.

The poorly understood rental market is critical to residential property prices — many of those who claim that property prices never fall should be looking closely at the rental sector before believing real estate propaganda over facts.