What now for Residential Property Investing in New Zealand?
What now for Residential Property Investing in New Zealand?
The Government’s recent announcement of changes to the treatment of residential property has been well documented. The likely impacts however have been less publicised. In this blog, we are going to look at what it all means for existing property investors.
Before we do that we should back up to look at what was happening in the market and why we believe they may have stepped in.
Let’s start with the charts that tell us the price change over time of NZ property over time.
Source: REINZ April 2021. Not inflation adjusted.
As you can see, there have been significant rises over time but little evidence that there have been any significant decreases. We see periods of flat line growth with growth rates resuming in the long run.
Why has this been the case?
Consensus on the reason for growth vary but there are several contributing factors.
A growing population with limited housing supply has certainly been a factor in driving demand and in turn putting pressure on prices. With the addition of low interest rates and somewhat generous tax systems that supported negative gearing this created a strong environment for investment. With these ‘incentives’ to invest in place, for many it made sense to invest in the market.
While investors continued to enter the market it exacerbated the issue of higher prices and made the environment more challenging for first home buyers. First time buyers’ savings could not keep up with the deposits required to make their first home purchase.
In this blog I will not debate the issue of whether residential housing is a social right or can be simply treated as a business investment, the reality was, prior to the change, it made perfect investment sense to purchase property in this fashion (concentrated risk not withstanding).
As we know, politicians have short life cycles and are very rarely bold in their strategic outlook, however they are certainly incentivised to make moves if there are grumblings on the ground amongst their voters. These grumblings have been accumulating for quite some time, and the Government appears to have just “snapped” and implement significant change. And these changes are significant.
The key change in our view was to remove mortgage interest rate deductions progressively over four years from existing homes.
Our initial modelling suggests that for an existing property investor on a top marginal or trust tax rate, with a moderate to high LVR (loan to value ratio), will move from potentially receiving a cheque from the IRD each year to paying a significant cheque each year. We calculated for a property investor with four or more “average” homes in Auckland or Wellington the difference could get into six figures.
While this impact on most investors will be small for the next 12 months it does become significantly larger over time.
We’ve modelled that for an owner of a $1m rental property on a 60% LVR interest only arrangement, it will cost them a further $1,000 in year one, progressively increasing to further $7,700 by year five. A figure not insignificant on a current rental yield of 2.5%. And if an investor buys an existing home for rental usage, then there is no interest deductibility at all from 1 October of this year.
Another change is the Brightline test extension to 10 years (from five), which applies to any unconditional made sales after 27 March 2021.
Additional changes have been made to the main home exemption, which matters for clients who may rent out their properties for parts of the year; some of any future gain on sale may be taxed.
So all in all, not favourable. But what are potential impacts going forward?
The difference in cash flows will be very material for some investors, particularly those who have multiple properties and don’t have a spare free cash flow from other sources to make up the difference. So we can expect to see some potential selling pressures (compounded by the tenancy act changes), which on balance may lead to outright house price declines. It should be kept in mind a 20% fall just re-winds the clock to where things were a year or so ago! At the very least, the tax shifts should remove perception that residential property investment is a “sure bet.”
We may see some investors look to sell older houses to replace them with new builds. The Government has effectively retained the incentives for investors who look to finance new builds via the proposed approach of allowing them to continue to claim the interest expense deductibility. The moves should also help accelerate new building activity given they have a much more favoured tax position now compared to existing homes. More new homes equates to greater supply to match demand, which may slow price rises.
Investors may also look elsewhere for investment opportunities. Smart investments are all about setting a strategic financial plan based on your personal circumstances and lifestyle ambitions and then deciding what is the best implementation approach required to achieve it.
As the “family home” is not subject to capital gains, people may choose to upgrade their homes instead of investing in a rental property. That is, instead of owning a $2m home, instead purchase a $3m home and, while you are unable to deduct the interest expense for tax purpose if you are borrowing, at least any increase in value will not be subject to capital gains should your circumstances change and need to sell within the 10 years Brightline test.
It may still make sense for those with cash on hand to buy residential investment property outright and appreciate a 3% return (currently). But one still needs to consider concentration risk as opposed to asset diversification, illiquidity of the asset purchased, and any likely future capital spending requirements (new roof, government requirements regarding rental standards). Additionally, while commercial property may now be a better alternative it is not without its own challenges…and a blog for another time.
Clearly there are significant challenges ahead. Our recommendation is to take a holistic view of your ambitions from both a lifestyle and financial perspective and seek advice and expertise wherever possible.
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