Growth in rents has continued to slow, increasing at around the slowest pace since before the global financial crisis, according to the figures from real estate analysts RP Data.

Indeed, Sydney is the only city where rent increases outpaced general inflation as measured by the Bureau of Statistics – the consumer price index rose 2.9 per cent over the year to March, while Sydney rents grew an average 3.7 per cent.

Perth (-0.5 per cent) and Canberra (-3.8 per cent) actually recorded falling rents, with the former giving back some of the previous year’s large increase, and the latter a victim of public service cuts that have reduced the major source of employment in the nation’s capital.

Yet, even as rental growth stagnates, a surge in property investment has driven home prices sharply higher nationally.

The average capital city home price increase was 11.5 per cent, but this was skewed up by a 16.7 per cent surge for Sydney and 11.6 per cent jump in Melbourne, the two biggest markets.

RP data’s senior research analyst Cameron Kusher says rental yields – the amount of annual rent as a percentage of the property’s purchase price – have now fallen from a national average of 4.3 per cent in April last year to just 3.9 per cent in April 2014.

“Across every capital city market we’ve seen a decline in rental yields because that rental growth just hasn’t been able to keep pace with the value growth we’re seeing,” he told ABC News Online.

The lowest rental yields were in the two cities that have seen the strongest price growth over the past year, with Melbourne at 3.4 per cent and Sydney at 3.9 per cent. The best yield continued to be in Darwin at 5.9 per cent, with Hobart the only other city above 5 per cent, at 5.2.

Mr Kusher says there is no way most investors could cover their mortgage repayments with yields at such low levels, even excluding the other costs of renting out a property such as repairs and agent fees.

“We wouldn’t see many instances in which you could find areas where the rental return would cover the cost of the borrowing,” he added.

Focus on capital growth not rental returns

Despite this, and despite the fact that Sydney and Melbourne currently have the two lowest yields, Mr Kusher says it is New South Wales and Victoria that are seeing the most investor activity, and there is no sign of it abating.

“The investor activity is still rising and at the highest levels we’ve seen in quite a number of years, so my thinking is that investors aren’t really focusing too much on those rental returns, they’re more looking at the capital growth potential,” he said.

“They probably do need to consider the rental return because that capital growth is not going to be there forever.

“We have seen some moderation in the level of capital growth over the last couple of months, and if we do eventually start to see some price falls, then these people are just going to be left with a low-yielding asset that doesn’t have much in the way of capital growth potential over the coming years.”

Late last year, well known fund manager Roger Montgomery applied the same principles he uses to pick stocks to Australian residential housing and found it fails a simple valuation test.

Mr Kusher says there have been signs of a slight increase in rental growth in Sydney and Melbourne over recent months, however he thinks it is unlikely that such improvements will match rising purchase prices.

“Given that we have seen, for the past 12 or 18 months, not much activity in that first home buyer segment there’s obviously pent up demand in that rental market,” he observed.

“But, overall, we would think that the capital growth across the capital cities is generally going to continue to outpace the rental growth, and what that means is we would expect further compression of yields over the next 12 months.”