NZ to go it alone on negative gearing reform

By Leith van Onselen

After Labor’s shock federal election defeat, it’s fair to say that negative gearing reform is all but dead and buried in Australia.

The same can’t be said for New Zealand, where the policy is nearing implementation. At the end of 2018, the Treasury and Inland Revenue released a Regulatory Impact Statement (RIS) assessing the policy.

The aim of the proposed law change is to level the playing field between property speculators/investors and owner-occupiers and improve housing affordability. The policy is also estimated to raise some $190 million in revenue:

The Government’s stated objective for ring-fencing rental losses is to reduce unfairness by levelling the playing field between property speculators/investors and owner-occupiers.  Currently, investors can have part of the cost of servicing their mortgages subsidised by the reduced tax on their other income sources, helping them to outbid owner-occupiers for properties…

Ring-fencing rental losses reduces the tax benefits enjoyed by property investors who buy property in anticipation of capital gain…

Key beneficiaries are expected to be:

  • First-home buyers.  Ring-fencing of rental losses could help improve first home buyers’ ability to compete with investors, improving housing affordability for home buyers, and potentially increasing the share of New Zealanders who own their own homes; and
  • Government.  Ring-fencing of rental losses is expected to increase tax revenue by approximately $190 million per annum.

First home buyers account for 22% of home purchases in New Zealand, compared with 39% for multiple property owners.  This may suggest that first home buyers can struggle to compete against investors and existing owner-occupiers in the market.  Home ownership rates have now fallen to 63% – down from 74% in 1991.

Speculative capital gain is a likely driver for investor activity in the residential housing market.  The average return on rental property excluding capital gains is low – the average gross rental yield on a three-bedroom Auckland property is 3% per annum.2  This suggests investors are buying property in anticipation of capital gain…

Falling rates of home ownership, untaxed capital gains, and increasing house prices contribute to equity concerns around housing, and there is strong interest in measures to improve housing affordability, especially for first home buyers.

In this context, negative gearing has come under scrutiny.  Negative gearing involves investors reducing their taxable income with rental losses.  The practice is relatively widespread in the New Zealand rental market – 40% of taxpayers with residential investment property report rental losses, with an average tax benefit of $2,000 per annum…

Many overseas countries have some form of loss ring-fencing of residential property, including the United Kingdom and the United States.

With the passing of these reforms imminent, CoreLogic yesterday released an assessment of New Zealand’s negative gearing reforms and concluded that it is unlikely to impact the rental market in any significant way:

The proposed tax ring-fence for rental property losses isn’t in force yet, but it is currently going through the ‘bill to law’ process – which starts with a select committee and then ends up before Parliament for the final stage. It would appear though that this is a mere formality and that when it becomes law the ring-fence will effectively be imposed for the current tax year starting 1st April 2019. In other words, investors need to be accounting for the ring-fence now – i.e. running their sums on the basis that a rental loss can no longer be used to reduce the tax bill on non-property income(s).

Certainly, some investors (especially those new to the game and/or with a big mortgage and hence greater likelihood of a loss) will be hit quite hard by this rule. But on the whole, we’re doubtful that the ring-fence will dramatically affect investor confidence or significantly reduce the stock of property in the rental sector.
First, because of the loan to value ratio (LVR) restrictions, investors have required a deposit of at least 30% for several years now and, on average, will be less likely to be making operating losses than in the past – hence, less likely to actually be utilising the tax advantage. Sure, many will still be using it. But it’ll be less common than in the absence of the LVR rules. Second, and perhaps most importantly, it’s a ring-fence, not complete removal. Investors will still be able to use losses to reduce their tax bill, just only within a property portfolio, not against non-property income.

It’s also reassuring to look back at investor behavior when the depreciation allowance was removed in April 2011. This was also a significant change in the rules around property investment, yet our Buyer Classification figures show that the upward trend in the share of purchases going to mortgaged investors barely paused for breath (see the first chart). To be fair, property price rises more generally were starting to kick into gear again around that time (see the second chart), and these gains may have swamped the effect of removing the depreciation allowance. And clearly, that factor isn’t as strong now, with values flat or slightly falling in Auckland and Christchurch for example, and slowing in many other parts of the country.

All that said, another factor to keep in mind here is the tighter availability of new interest-only loans in the past few years, as well as the reduced ability for investors to roll over existing interest-only lending. Given that interest-only loans (and hence lower mortgage payments) are an important tool for negatively geared landlords, it’s conceivable that some will have already looked at their sums (regardless of the ringfence proposal) and decided to sell properties that don’t stack up anymore. This may have affected rental supply in some areas and would be another factor helping to explain the gradual slowdown we’re seeing in property values around the country.

Of course, this would only serve to lessen the potential effect when the new law does actually come into force. Moreover, let’s not forget that just because a landlord sells their property, it doesn’t necessarily vanish from the rental stock – it may well be snapped up by another investor, perhaps with more equity behind them. In addition, rather than selling, landlords may just hold their properties for longer than they planned in order to compensate for the effect of the ring-fence on their expected return. That would just reinforce what we’ve already started to see in the past year or two – that is, investors holding for longer than in the past, and also relative to other buyer groups, such as first home buyers (see the third chart).

Bottom line, we doubt that the looming tax ring-fence for rental property losses on its own will drive a sea-change in investor behaviour.

It’s a shame CoreLogic’s Australian arm couldn’t present similar dispassionate analysis, since it would have helped debunk the misinformation spread by the Coalition and property lobby against Labor’s policy.

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Unconventional Economist

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