Aside from the global pandemic, the NZ housing market has hogged the local media headlines for the last year or more. House price increases are rampant in most parts of the country, perhaps 22% and climbing, and this has supported a view that the housing market has become a one-way bet, benefitting property owners and bolstering investor demand at the expense of those wanting to get onto the housing ladder. Something needed to be done.
Recently, the government announced several policies to bolster housing affordability and supply. Ultimately, as a country we need to build more homes and apartments, but it will take time for that to occur. In the interim, the most recent headline-grabbing policies attempt to slow the buying demand from residential property investors, who typically account for around 30% of all property purchases and perhaps own more than 600,000 properties. Two moves were made in this area:
Bright line. This means paying tax on any capital gains made if an investment property is sold within a set period. The extension of the bright-line test from 5 years to 10 will effectively see a longer lock-in period for property investors and probably fewer property sales, and
Interest deductibility. The policy that caught the most attention was the removal of interest rate deductibility from investor housing. Normally, investments in property are taxed as per other businesses, which means that the total income has all business expenses deducted before a net income figure is reached. Tax is paid based on the net income. This means that rent has all expenses such as rates, insurance, interest, maintenance, and so on deducted from it – whatever is left is the taxable income. Starting from October this year, deductibility on the interest will be reduced in 25% increments for existing property investments and will be fully phased out by April 2025. (There is likely to be some sort of exemption for new builds, although how this might be done is yet to be decided). This policy will generate a significant amount of additional tax to be paid by property investors and will weigh on investor cashflows, even though other usual non-interest expenses are still deductible.
Is the change that bad?
Some property investors and those in related industries such as accountants and real estate agents have been quite vocal about the change, though maybe it’s not as bad as it first seems. Consider this example:
For a property investor with $1 million in lending, an interest rate of 2.5% (for planning purposes) equates to $25,000 in interest payments each year. If tax is payable at the 33% rate, then depending on other costs such as council rates and maintenance etc. that investor might have to pay an extra $8,250 in taxes each year. Given the rate of capital gains that have been achieved lately – of course acknowledging past returns don’t guarantee future results – many property investors could do well by leaving their current strategy unchanged.
In addition to the tax changes, the Government has announced changes to the First Home Loan and Grant Scheme by increasing both the income and house price caps. More on these policies can be found here.
In announcing these policies without prior consultation, our democratically elected representatives caught more than a few people off-guard. This has caused concern in business and accounting circles, who especially objected to the tax deduction being labelled a loophole in the policy announcements despite being consistent with internationally-accepted accounting guidelines. The basic principle is that costs incurred in generating business revenues are legitimate deductions from taxable profits. Interest is a cost, so it should be deductible.
What will the impact be?
The simple answer is that at this early stage nobody knows. NZ’s major banks have businesses built on the housing market, and even their opinions are nearly all different.
However, most commentators and experts generally agree that:
No government anywhere has a good track record of intervening in a market and providing a meaningful influence over prices.
Higher taxes don’t usually make things less expensive, as a country we cannot tax ourselves wealthy. True wealth comes from hard work, calculated risk, ambition, innovation, productivity, and rewarding success.
If only a set number of properties are available, say 10, it doesn’t matter whether investors or owner-occupiers own them, those 10 houses can still only house 10 families.
The main issue that keeps property prices up in NZ is a lack of supply, though many gurus disagree over why the lack of supply exists!
Here at Become Wealth, in our humble opinion certainly steps need to be taken to resolve the housing crisis, though nobody wins when the lack of housing supply is pitched as a “us versus them” battle in the public arena between investors and first home buyers. Scattered reports are emerging of open hostility to anyone perceived to be a property speculator, which is a shame in a country where we all like to think of ourselves as equals. Perhaps media criticism of some excitable or outspoken property investors is valid, and we appreciate that many first home buyers may be tired of being outbid at auction. That said, property investors provide a valuable service to most tenants, and it is often overlooked that most NZ property investors are mum & dad investors with one investment property – there are no massive corporations that own blocks of houses and apartments which is common in places such as the United States. Before property investors became the latest target of the blame game, various other scapegoats have been held responsible for NZ’s housing woes, such as foreign buyers. When foreign buyers were banned from buying NZ property a couple of years ago there was no impact on house prices, which continued to climb. After that, immigration was blamed by many, but Covid-19 stopped immigration in its tracks and housing prices continued to rise. Time will tell whether the same happens this time around…
This is an interesting situation to say the least and given the uniqueness of the non-deductibility of investor’s interest, there are a number of possible developments. At this stage our team has more questions than answers, including:
Will things change much for first home buyers?
Will rents go up like most commentators expect?
Will housing prices stabilise, rise, or even fall?
Will the exemption for newly built residential property go through as anticipated?
As the new rules don’t apply to agricultural (including dairy farms and orchards) and commercial properties, will wealthier investors turn more to these sorts of properties?
There are detailed taxation design issues that need to be resolved for existing and future property investors. Some immediate questions include what types of residential property will be subject to the interest deductibility restrictions – e.g. are retirement villages intended to be caught? Air BnB? What about when debt is held in a company? Will changes apply to offshore rental properties? Is there a continued need for rental loss ring-fencing? And so on.