The Housing Package: Keep calm and act like a camel….

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The NZ Government has decided they would rather pass a housing package through the eye of a loophole than confront the obvious supply side constraints in the housing market. But this camel has more than one hump and the unintended consequences of their policies are likely to hurt the people the package is designed to help 

How should new and existing property investors respond to the changes? Keep calm and continue investing in good property is the message from Erskine & Owen. This week’s newsletter looks at the policy changes, expected impacts on the property market, and strategies for property investors to mitigate those impacts.     

The Changes 

Last week the government proposed two key tax changes that will impact residential property investors: 

  1. Extension of the brightline test from 5 years to 10 years: The bright-line test imposes a capital gains tax on residential property by deeming gains on sale of property that would ordinarily be capital in nature to be subject to income tax. Investors acquiring residential properties after 27 March 2021 will now need to hold the property for 10 years to avoid the impost of this tax.  
  2. Removal of tax deductibility for interest on loans for residential property investment: Property investors acquiring existing residential properties after 27 March 2021 can no longer claim interest on borrowings to purchase the property as a deduction against rental income. Tax deductions for interest on all borrowings for existing residential property investments will be phased out over four years and eliminated by 1 April 2025.   

It’s important to note that the changes to the bright-line test only apply to acquisitions of residential property after 27 March 2021. The removal of tax deductibility for interest expenses will impact all owners of residential property but current property owners can deduct a portion of their interest costs over the next 4 years. 

To encourage investment in residential construction, ‘New Builds’ will not be subject to the extension of the brightline test to 10 years. Interest deductibility on borrowings for “New Builds” is less certain – the government has indicated that a consultation process will take place before a final decision is made. 

The Impact  

It is disappointing the government has focused on the demand side of the housing equation rather than confront obvious supply side constraints. Restrictions to the supply of land for residential development are an obvious impediment to housing supply and an overhaul of the Resource Management Act must be prioritised to alleviate this issue. While the housing package did include funding for infrastructure and construction training, the delivery of these additional resources will take time and we run the risk of killing rental supply in the interim 

Most market commentators believe the housing package will deliver the desired dampening of demand for residential property and subdue the relentless rise of house prices. Ultimately house price growth of around 27% over the last year is unsustainable and a gentle correction to more modest rates of increase is desirable. Without corresponding increase in the supply of housing stock, it seems more likely we will see a gentle correction rather than a destructive crash in residential property prices.   

There will be unintended consequences for the government from the introduction of this policy. We expect to see rents continue to rise as landlords look to recover interest deductions foregone and future tax on disposal of their residential property investments. Increased rents will make it harder for those saving for a home deposit to get on the property ladder. There is no guarantee property investors will switch to new builds – the possibility the residential property market might remain depressed for some time could turn off the demand tap completely.      

The Response  

Did residential property investing immediately become a bad investment when Grant Robertson announced his housing package last week? Of course not. The fundamentals of property investment are as strong as ever – the policy may reduce cash incomes from residential property investment but is unlikely to significantly impact the growth in value of those properties over time. Successful property investors will continue to build wealth via property using disciplined acquire and hold strategies. 

But any investment strategy needs to be monitored and reviewed regularly. Now is a good time to look at how your property portfolio is structured and administered, refine your approach and strategy, and consider opportunities to reduce the impact of these policy changes.

Here are some options you might consider: 

  • Managing interest rate exposure: Consider the impact of future increases in interest rates on your rental property cashflow.Lock in fixed rates to limit exposure as appropriate. Current 5 years rates at around 3% provide an opportunity to keep your rate lowfor an extended period.
  • Restructure debt: Some property investors may be able to restructure their debt in order to retain interest deductibility e.g. business owners with low business borrowings. 
  • Review income distribution: For investment properties owned by trusts there may be an opportunity to distribute income to beneficiaries (usually your children) at lower tax rates. Distributions can fund payments like school fees, university costs, etc.
  • Add more space to increase rents: Can you add extra rooms, a minor dwelling, or just spruce your rental up, to provide an opportunity to increase rents? With low interest rates available to fund development the ROI on these projects is often worth the effort. 
  • Maximise deductible expenses: Make sure you claim all possible expenses against your rental property income. Consider travel, motor vehicle running costs, home office expenses, cleaning/rubbish removal, repairs and maintenance, appliance depreciation, advertising, bank fees, stationary/printing costs, insurance, and rates.
  • Review rent levels: Rents are expected to increase more rapidly over the period that interest deductibility is phased out. Landlords must ensure rent levels are regularly reviewed against current market rates. 
  • Consider commercial property investment: Interest deductibility is still available for investments in commercial property and the bright-line test does not apply.  

Many of these options require sound advice from a tax adviser with specialist knowledge of residential property investing. 

 And what about the new property investor yet to make their first foray into the market? Should they change their approach? Like any journey, you can’t get started without taking the first step. Property markets go up, and property markets go down. But the residential property market has been a great store of value with house prices increasing annually at almost 7% p.a. for the 20 years to September 2020. So give our property experts at E+O a call, make a plan, and get your property investment caravan moving. As a wise man once said: 

Like a caravan of camels walking in the dessert, be durable against the adversities of life and walk with decisive steps.         

 

 

 

 

 

 

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