The budget and its impact on the property market

15 June, 2010

After signalling back in January that they were seeking to make changes to the tax treatment of investment properties, the details finally emerged in the Government’s Budget announcement on May 20th.

This ended months of speculation as to the nature of the changes, and much debate over whether the singling out of property investment was unfair. The Government was keen to discourage what it called ‘unproductive’ investment in property. Some of the more severe measures that could have been introduced by the Government such as capital gains tax, and ring fencing of profits had already been ruled out pre-budget, so it was widely expected that the changes would focus on tax on investment properties held in companies, and on depreciation on buildings.

Here is a brief summary of the changes to tax measures that affect the property market:

• The ability to claim depreciation deductions for buildings with an estimated useful life of 50 years or more has been removed. This takes effect from the start of the 2011/12 income year.
• Changes to the tax rules for qualifying companies (QCs) and loss attributing qualifying companies (LAQCs). This takes effect from income years starting on or after 1 April 2011.
• Property investors can no longer use rental losses to offset their personal income and therefore claim Working for Families. This takes effect from 1 April 2011.
• Inland Revenue has been given an additional $119.3m over the next four years to enforce the new tax regime, including targeting property investments that it believes have been used for tax avoidance.
• The top personal tax rate has been cut from 38 per cent to 33 per cent. This reduces the incentive for higher-income earners to claim losses on investment properties to offset their personal tax.
• GST will increase from 12.5% to 15%. While GST is not paid on mortgages and rent, the increase will affect the cost of building and materials, maintenance, insurance etc.

According to the government "these changes will generate at least $2.48 billion additional revenue over the next four years, which can be returned to all New Zealand taxpayers as part of our package of across the board tax cuts."

The Budget forecasts assume that the tax package will reduce house prices by around 2% than would have otherwise been the case, and The Treasury estimates the impact on rents of Budget 2010 tax changes will be slight, with rents rising about 1.4 per cent more than they otherwise would have over the next three to five years.

Impact on property prices

There is some divergence of opinion over what impact the budget will have on property prices.

BNZ chief economist Tony Alexander is picking house prices to drop slightly in the short term before rising again next year due to a housing shortage.

"As we have long noted we are not building enough houses in New Zealand and investors will now build even fewer. We expect this growing imbalance between demand and supply to restrict price declines ... and lead to mild rises again over 2011."

Property Institute president Ian Campbell says house prices could fall by between 5% and 8% over the next six months as some investors get out of the market.

Commentators have also suggested that many property investors, particularly those with highly geared portfolios would be forced to sell some of their properties, and this would push prices down.

The Real Estate Institute does not expect significant jumps in prices or rents, saying tax advantages are just one part of the investment equation.

Westpac economist Dominick Stephens said “The tax changes are a clear negative for house price growth”.

He believes the biggest impact comes from a drop in the top tax rate which will narrow the gap between the top income tax rate and capital gains. Westpac estimates that over time this will reduce the value of housing by 10% relative to what it would have been under a 38% top tax rate.

“That’s not to say that prices will fall by 10%; more likely, they will stay flat for longer than otherwise, while incomes catch up.”

Westpac also expected that the removal of the ability to claim depreciation will affect the most leveraged and cash-poor investors who will need to sell their properties to less-leveraged investors. This would depress property prices in the short term, especially at the lower value end of the market where investors are more active.

There is a contrary view that predicts prices will rise. Arron Davis, a property seminar promoter says the Budget will not force out landlords and drive down house prices. Instead he believes the budget would create a stronger economy.

"When the economy is growing and there is inflation, property prices go up," Davis said.

“The main financial impact for property investors arising from the budget is changes to rules on depreciation – changes that will cost an investor on average only another $15 a week per home.”

“The fact that GST will increase means that the cost of new housing and section prices has to go up which will bring along established home values with them” Davis said.

This view is supported in part by Richard Carver, director of house-builder Jennian Homes. He expects the cost of building to increase because rising GST would push up the price of land and buildings. Any staged payments by people in the midst of building made after October 1 would incur higher GST, he said.

"Builders will be under pressure to have homes completed before the increase date," he said.

Impact on rent

Many commentators expect moderate rent rises as a result of the budget. This is both as a result of direct increases in the cost of maintenance, insurance, building etc, but also a shortage of rental properties, and landlords looking to regain their losses from no longer being able to claim depreciation.

The Property Investors Federation predicts greater rises in rents than most. It estimated the loss of depreciation will cost landlords around $24 a week for the average property.

"While this will not all be applied to higher rental prices, it is estimated that rents will rise by 4.5 per cent to 6.5 per cent nationally, rather than the 1.4 per cent expected by Treasury estimates."

Director of Massey University's real estate analysis unit Bob Hargreaves said rents were more influenced by what was affordable.

"Rental affordability from a tenant's point of view is more a function of wages," he said.

For our part we have seen little impact so far from the budget. There has been no apparent increase in enquiries to QV Valuers from either buyers or sellers. It appears for the time being things will remain as they have been for the past few months with low buyer confidence and sluggish activity. With GST not increasing until October and the property tax changes not until next year it may be some time yet before we see how investors react to the changes.

Source: Jonno Ingerson - Research Director, PropertyIQ