My column this week was going to be about the different layers of people driving house prices up recently, and the unusual effect of the change in loan to value ratio rules encouraging investors to buy before they needed a 40% deposit upon settlement.
The first of the three layers comprises people who are buying either because they have shifted jobs or locations or because that is what they had long been planning to do. The second layer comprises those who held off buying from perhaps three years ago and are now catching up on purchases they did not make back then because they felt the time was on their side. Making up the third layer are people who had not been planning to buy until next year but have jumped in because they are worried about prices running away from them.
These shifts of layers through time help explain periods of price boom and retreat – and the discussion is actually relevant in light of what the Government announced this week. You will know all the details well by now, but let me note that the allocation of $3.8 billion to help fund infrastructure is excellent, as is the $2 billion allocated to Kāinga Ora to help fund social housing land purchases.
The extension of the bright-line test from five to ten years was expected and does not really have any major implications. But let’s look at the announcement we did not expect: the removal of the ability of all new investor purchasers to deduct interest costs from this week and a gradual reduction in the ability of those already owning investment properties to deduct such expenses over the next four years.
I had expected maybe 10% of interest costs to no longer to be deductible. For the 12% of people who buy an investment property with cash, there are no implications. But for the 24% on average who do so with a mortgage, this changes the equation.
Whereas before rental income of $20,000 might be offset with $15,000 of interest cost to deliver a taxable income of just $5,000, now that taxable income will stand immediately at $20,000 for new purchases, and eventually become that over four years for the many people already owning an investment property. The tax bill will rise (at a 33% rate) from $1650 to $6600.
What are the implications? My experience over the decades has been that many Kiwi landlords have not raised rents to levels they know the market could bear because they empathise with their tenants and could await capital gain to slowly accrue (sometimes swiftly) over time. Now the cost of doing that is much higher and we are likely to see quite strong rises in rents over the next four years.
Many people who were thinking about buying an investment property now will not do so. Some people owning them will sell. The third layer of people discussed above will shift back to buying in the future. This will place downward pressure on prices which have risen on average nationwide by a ridiculous 25% since June. In many months for the remainder of this year prices will fall, but in 12 months we will almost certainly still have prices well above where they were in March 2020.
First home buyers will gain through having lower entry prices for a while and less competition at auctions. But their ability to save a deposit will be reduced by higher rental costs on average.
There will be extra demand for new properties which may open up a price difference with existing residences, though some details still look like they need to be worked out regarding interest cost deductibility for new builds.
Eventually, we will reach a new equilibrium in the housing market – probably within 12 months. From that equilibrium, prices will probably rise on average long-term by 4% to 5% per annum rather than the average 6.8% seen since 1992. House construction will be boosted, especially with the moves to help fund infrastructure. But the pace of supply growth will be limited by the Government’s increasingly expressed determination to limit migrant inflow from next year when the borders full open again.
That will be good for upskilling and lifting great numbers of Kiwis into the construction sector. But the trade-off will be less speedy construction growth than would otherwise be the case.
Three final points: the news reduces the chances of the Reserve Bank raising its official cash rate before the end of 2022 – though it does not rule that out. The likelihood of debt to income ratios and restrictions on interest-only lending being introduced this year has fallen substantially. And prospects for renters at the low end of the socioeconomic spectrum have become decidedly worse and the news today will bring a rise in homelessness and extra blowout in the statehouse waiting list as the pool of rental properties shrinks and becomes more expensive.
– Tony Alexander is an economics commentator and former chief economist for BNZ.
Additional commentary from him can be found at www.tonyalexander.nz.This entry was posted in Property Market. Bookmark the permalink.