Tony Alexander Update April 2021

Impact of housing policy changes In my last article written a month ago, the final sentence read like this “The government primarily, and the Reserve Bank almost reluctantly, are likely to look to hasten the pullback of investors over the remainder of this year.”

I expected in March or more probably the May Budget, that there would be the extension of the brightline test announced and thought there may be some tinkering with ability to deduct interest costs from rental income. But like everyone else I did not expect that existing investors in property would lose 25% of their deductibility right away, reaching 100% four years from now. The deduction has disappeared for new investor purchases of existing dwellings.

It has not however been altered for new purchases of new dwellings. For the moment there is confusion about what qualifies as a new build. But that will be sorted out and the end result will be that the government will have incentivised investors contemplating a purchase to focus on new builds rather than existing houses which they want left aside for first home buyers to be able to purchase.

But there are many consequences of the changes announced, and the way in which the announcement was made without consultation, without reading Treasury’s advice, and in opposition to promises made ahead of the election, suggests there could easily be further changes made down the track.

Here are a few of the things we can reasonably expect to see happen.

First, rents will go up at a faster pace. Already they have risen by 24% since Labour were elected in 2017 compared with rises of 14% in the three and a bit years before that election, and 11% in the period before that. Rents will go up because the disincentive to own investment property will see some investors sell and many not buy. This will reduce the supply of rental accommodation.

In addition, the average increase in investor costs of about $5,000 a year will be passed on into rents. The effects of these changes will be to make life much more difficult for renters in terms of accommodation cost and availability.

In fact, in a special survey I ran of property investors on March 29, 74% of the over 3,600 respondents said they will now raise rents at a faster pace than they were planning before the policy changes.

Those at the low end of the socioeconomic spectrum are likely to suffer most and we can expect to see further growth in the number of people seeking state housing, and a rise in homelessness.

Ahead of the 2023 general election there is a good chance that Kainga Ora will be in the market offering generous long-term leases with full remediation of property damage to investors prepared to offer their property to the state for its use – which will worsen availability for other users.

Second, incomes of investors will go down and this will not only cause rents to rise as noted, but it will also lead to cutbacks in investor spending in areas like improvement of the property as well as personal expenses such as travel. Reduced demand for existing properties will place some downward pressure on average prices. This reduced spending effect will be accentuated by the increased reduction in costs which investors can achieve by paying down their mortgage rather than letting it run.

Third, first home buyers will find their route to home ownership more complicated than before. Building up a deposit by rentvesting – purchasing a rental property for capital gain whilst renting oneself near work – will yield less ongoing return and a reduced after-tax nest egg when selling because of the extension of the brightline test.

Investors will switch to new builds and this will leave fewer new townhouses in particular available for first home buyers, while raising the prices which developers can charge for their units.

Fourth, many people are of the view that the new rules will lead to lower inflation. However, if house price inflation does slow this will not affect the measure of inflation, the Consumers Price Index, as house prices are not included in that measure. But the CPI includes rents, and it includes the costs of building materials which will rise. Thus, already at the time of writing this article, most of the immediate fall in bank wholesale funding costs as a result of the March 23 announcement had been reversed. Increases in fixed mortgage rates still look likely in the next few weeks.

Fifth, there will be a spur to construction. However, the rise in supply to come will not be immediate for a number of reasons. There is a shortage of builders and this could get worse because of a building boom in Australia over the next two years as near 100,000 people have taken advantage of a special subsidy to finance home construction.

In addition, the supply chains for building materials have been compromised and just got worse for structural timber in New Zealand. Materials prices are climbing.

Sixth, land prices will rise. This will happen not just because of the extra demand for new housing set to come from investors. Developable land is already in short supply and any rise in demand in such a situation can actually produce quite a strong price response. There has also been a special $3.8bn fund created for councils to call on to help finance infrastructure to support new subdivisions. $2bn borrowing ability has also been allocated to Homes and Communities (the old Housing Corp.) to purchase land for social housing development.

Will house prices fall? Not in terms of annual rates of change. But even before March 23 my expectation had been that we would see 1-3 months of price declines after March data get released simply because of the extreme surge in prices over February and probably March as investors looked to buy ahead of the 40% minimum deposit requirement coming in.

The falls will simply give back some of the ridiculous 25% rise in average NZ house prices since lockdown ended last year. Will the changes announced be followed by additional tightening moves by the Reserve Bank? Quite possibly not. The Reserve Bank’s job is to focus on stability in the financial system and the quality of lending which banks are doing. There has not been any worrying deterioration in the quality of that lending during this price boom. That is why the Reserve Bank only reluctantly and belatedly restored Loan to Value ratios under pressure from the banks themselves.

We can reasonably expect that investor demand for credit will now ease, and to the extent the Reserve Bank might have been starting to have some concerns, those concerns will now be backing off.

However, it is likely that the Finance Minister will grant the Reserve Bank ability to use Debt to Income rules in the future – but only if he can be sure that when used they will not target first home buyers. That will be hard to do as the Reserve Bank has many goals, but none of them are a reallocation of home ownership in New Zealand.

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By Tony Alexander