The housing market nationwide is delivering about the rate of capital gain an investor would need to justify buying an average house, says Westpac chief economist Dominick Stephens, but it could start to look frothy if interest rates rise, as he suspects they will.

The net rental yield on a residential investment property, once maintenance costs and management fees are taken into account, is generally less than the mortgage rate required to finance the property. Investors are willing to accept such low yields only because they anticipate (tax-free) capital gains.

"During the early 2000s a mere 3 per cent long-term capital gain was required to break even, because interest rates were so low and house prices were low relative to rents," Stephens said.

"No wonder there was such a craze for property investment at the time." A reduction in interest rates meant the required capital gain was less.

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"A big lift in [house] price relative to rents absolutely should have been expected, given the big drop in interest rates in the past 20 years. That adjustment, and more, seems to have occurred during the 2000s, but it's a one-off."

As house prices and interest rates rose during the 2000s, it became harder to justify investing in property on the basis of expected capital gain. By the eve of the global financial crisis, a long-term capital gain of 5.7 per cent a year would have been required.

"Today's numbers look more reasonable. We calculate that a long-run capital gain of 4.4 per cent per annum is required to justify investing in an average house today. However, that calculation is based on today's interest rates.

"We used a mortgage rate of 6.3 per cent, the average of today's two-year and five-year fixed mortgage rates," he said. "Should interest rates rise in the future, as we suspect they will, the required capital gain may once again rise into unrealistic territory."

Quotable Value's monthly index suggested house prices rose about 1.5 per cent in the September quarter, while the Real Estate Institute's figures have the annual increase falling from 4.8 per cent in August to 4.1 per cent last month.

"All up, our long-held forecast for house price inflation of around 5 per cent this year is still looking about right."

These results were based on national averages. The economics of an investment would vary house by house, suburb by suburb, city by city.

"Across New Zealand in higher-priced areas, rental yields are lower and expected capital gains are higher," Stephens said.

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"Rental yields are down around 1 per cent in the top suburbs in Auckland and as high as 10 per cent in some of the smaller regions where capital gain expectations aren't quite so high."

Of the variables in Westpac's model, the implied expected capital gain was most sensitive to interest rates.

"If you really could fund a house forever at 6.3 per cent you would need a 4.4 per cent in capital gain to make up for the loss you are making at the moment on the difference between the net rent and the servicing cost of the mortgage.

"But if it is really going to cost you 7 per cent, then the required capital gain is going to be higher - and more than just 0.7 percentage points higher."