29 May Implications Of Government Policy Changes For Investing in Residential Property
by Shahrukh Abdali, AFA, CFA
This article is the second of a series aimed to address some of the common topics our clients ask us to comment on. I hope the information provided will be useful to readers when contemplating financial decisions. Note that the information provided is not personalised financial advice and does not consider your personal circumstances. I encourage you to take advice from an Authorised Financial Adviser before taking investment decisions.
In the first article, I discussed some of the key factors responsible for the rapid increase of property prices in New Zealand over recent years. These included record-high net migration combined with easily obtainable and cheap credit (mortgages) fuelling high demand for residential houses. Simultaneously, a lower supply of residential housing than required to meet the high demand created a housing shortage, which drove up the property prices. I concluded that these three drivers of property prices are starting to wane and that I expect New Zealand property prices to remain flat or experience low growth for the foreseeable future. The first article can be read at: http://saturnportfolio.co.nz/whats-driving-capital-gains-residential-property/
In this article, I discuss five government policies aimed at housing and what these policies potentially mean for current and prospective property owners, particularly property investors.
- Ban on foreign buyers
The New Zealand Labour and New Zealand First coalition government announced their plan to amend the Overseas Investment Act 2005 soon after taking office. The Overseas Investment Amendment Bill (OIAB) was introduced to Parliament on 14 December 2017 and had its first reading in Parliament on 19 December 2017.
The core objective of OIAB is to provide affordable housing for first-time buyers and to make it more difficult for overseas buyers to buy existing properties, the later perceived to have contributed to speculation of property prices.
If the OIAB is passed by parliament, it is expected to negatively affect overall demand for property by reducing the overseas demand. At the time of writing, submissions were open for the proposed OIAB and the Finance and Expenditure Committee was scheduled to report back on 31 May 2018.
- Extension of the bright line test
On 29 March 2018, the bill to extend the bright line test from two years to five years became law. This extension means that profits from residential investment properties bought after 29 March 2018 and sold within five years of purchase will generally be taxable. The two-year bright line test will still apply to residential properties bought after 1 October 2015 but before 29 March 2018. The bright line test does not apply to owner-occupied properties. This extension of the bright line test is expected to discourage short-term investment in property.
Property investors will need to carefully consider the implications of this change when buying residential properties because changes in their own personal financial circumstances that necessitate selling their investment properties are more likely to be captured by this extended bright line test. Despite not intending to make a short-term capital gain, a forced sale could incur capital gains tax. This extension of the bright line test will reduce the attractiveness of investing in property thereby negatively impacting the overall demand for property.
- Ring-fencing of rental losses
At present, losses on residential property investment can be offset against other income to reduce overall taxable income. It is argued that some property investors in New Zealand deliberately structure their property investments to create tax losses on their property investments to reduce their overall tax payments. This provides property investors (particularly highly-geared investors) an advantage by having part of the cost of servicing their mortgages subsidised by the reduced tax on their other income sources.
Pending the approval of proposals in an IRD paper, from 1 April 2019, property investors will lose their ability to offset losses from their residential property investments against their other income (e.g. salary or business income), to reduce their income tax obligations.
It is expected that this directive will remove a major attraction of investment in property further negatively impacting the demand from property investors.
- Favourable policies for tenants
The government announced a package of proposed rental policies aimed at boosting tenants’ rights. These include:
- A proposal that letting fees should be incurred by the landlords instead of the current practice where the tenant must pay for these.
- A proposal to increase the notice period landlords must provide tenants to vacate a property. The proposal is to increase this notice period from the current 42 days to 90 days.
- A proposal to abolish all no-cause terminations of tenancies. Currently, landlords can terminate tenancies with a ‘no cause’ 90-day notice. Landlords can use this clause to replace poorly behaving tenants with potentially better tenants.
- A proposal to limit rent increases to once a year.
- A Healthy Homes Guarantee Act which commences on 1 July 2019. After this date, all landlords must ensure that their residential rental properties comply with the healthy homes standards. Although this Act is not expected to impact all landlords, it is an extra cost and a hassle for landlords with properties that currently do not meet the healthy homes standards.
All in all, these proposed tenant friendly policies are expected to reduce the attractiveness of owning properties for rent, thereby negatively impacting the demand for property from property investors.
- KiwiBuild programme
The government is targeting to build 100,000 affordable homes over the next 10 years, with 50% of these in Auckland. In the short-term, the construction sector faces capacity issues due to a shortage of construction labour and material. This was highlighted when the Treasury halved its forecasted progress rate on KiwiBuild in the recently released Budget 2018.
Contingent upon overcoming the bottlenecks in the construction sector, KiwiBuild is expected to significantly enhance the supply of housing in New Zealand.
The laws of economics suggest that a decrease in demand for goods (property in this case) will lead to downward pressure on prices assuming that the supply of the goods does not also decrease. The same laws suggest that an increase in supply of goods will also lead to downward pressures on prices provided that demand does not also increase. As discussed in this article, the government policies are expected to decrease the overall demand for properties while potentially boosting the supply of new properties.
Given the current shortage of housing I do not expect a major drop in property prices in the short term. However, some of the “tail winds” that have supported strong capital gains in residential property over recent years risk being replaced with significant “head winds” with the potential for much slower growth in property prices going forward. It is prudent to diversify capital across asset classes and across different regions of the world. This reduces the risk of a significant capital loss that can incur through holding most of the capital in one asset class, which then experiences an unexpected downturn.
In the next article I will consider the implications for the overall return on residential property in the absence of capital gains.