We Need to Talk About Auckland (part 2)
In the second of our series of updates about residential property, we discuss the changes made by New Zealand’s ‘Rebel with a Cause’, Reserve Bank Governor Graeme Wheeler.
I know what you’re thinking, the somewhat bookish looking Graeme Wheeler hardly summons images of the quintessential ‘Rebel Without a Cause’, from the 1955 movie of the same name, infamously portrayed by James Dean.
Maybe not, but perhaps that’s because Graeme Wheeler knows what he’s rebelling against. During his almost three years in the job, Wheeler has developed a reputation for Central Bank activism that none of his predecessors came close to.
This began with the introduction of the first of the so called macro-prudential tools (itself a new innovation) – high loan-to-value lending restrictions in 2013. And has culminated, for now, in the creation of a new asset class – ‘loans to residential property investors’ and an Auckland only lending rule targeted at slowing house price growth in that region by two to four percent per annum.
The first change, restricting new high loan-to-value-ratio (LVR) lending (lending to purchasers with less than 20% deposit) to no more than ten percent of all new lending, called the LVR ‘speed limit’ by the Reserve Bank received lots of media coverage. Many railed against the impact on first home buyers.
The Reserve Bank’s own data indicates that the LVR restrictions did have the desired cooling effect (1). Economists and Central Bankers around the world agreed, praising Governor Wheeler’s use of macro-prudential tools and named the Reserve Bank of New Zealand the Central Bank of the year (2).
The second change, creating the new asset class ‘loans to residential property investors’ is much more wide reaching and could have a material impact on house prices. The change was made after extensive consultation and means that any retail mortgage secured over a property that is not owner-occupied will be classified as a ‘loan to a residential property investor’ from 1 October.
Loans to residential property investors will attract a higher risk weighting than owner-occupier mortgages and require greater capital be held by banks in reserve.
This should result in less lending to residential property investors at higher interest rates. That should decrease demand and house price inflation.
The new Auckland only rule, in staid Central Banking terms is a vice like tightening of LVR restrictions. The changes will require all residential property investors in Auckland using bank loans from 1 October to have a deposit of at least 30 percent. On top of an expectation that they may pay higher interest rates, that’s tough.
In a move that recognises that maybe Auckland is different, the Reserve Bank is also easing restrictions in the rest of New Zealand. From October, up to 15 percent of all new lending outside of Auckland can be high LVR lending.
As if all that wasn’t enough, it comes after Grant Spencer Deputy Governor, commented in a speech to the Rotorua Chamber of Commerce earlier this year, that the Reserve Bank considers that greater attention needs to be given to the tax treatment of investor housing (3).
That may not seem like a very radical statement, but is actually quite a big deal. The Reserve Bank has a pretty long track record of trying to keep its nose out of politics. This rather pointed comment indicates an increasingly proactive approach by the Reserve Bank in this arena.
While it may not be James Dean banging his fist on a doorframe in his iconic red jacket, the sum of these changes and comments is about as close as your average Central Bank gets to doing just that! What I think we can take from all this is that we don’t have just an ‘average’ or ‘vanilla’ Central Bank.
With approximately 60% of all New Zealand bank lending made up of residential mortgages, more than $200 billion, and $73 billion of that lent to residential property investors we think that’s a good thing for ‘NZ Inc’.
In our next and final update about property in New Zealand we’ll write about what house price inflation has been and what the banks might consider doing about it.
Scott Rainey is an Authorised Financial Adviser
Disclosure statement is free and available on request
Residential Property – We need to Talk About Auckland
In the first of a series of updates about residential property in Auckland and New Zealand we discuss the recent announcement by Prime Minister John Key on changes to the way gains on residential property are taxed.
To begin with there’s actually some debate as to whether or not there is a problem with Auckland house prices. Given Auckland house prices rose 18% when overall inflation for the year to March was 0.1%, and in April the median house price to income ratio for Auckland was 8.36 times versus New Zealand’s overall ratio of 5.54 times (a median multiple of 3.0 times or less is considered affordable 1), it is difficult to see why there’s a debate.
In a pre-Budget release earlier this week, Prime Minister John Key announced (2) a number of new measures in the Budget aimed at ensuring that people buying and selling residential property for profit pay their fair share of tax.
The changes amount to clarifying the existing rules, under which anyone who buys property with the intention of selling for a gain is liable for tax. This will enable more effective enforcement by the IRD and introduce new rules to help track foreign investors.
The new measures will include:
• The introduction of a new “bright line” test to tax gains from residential property sold within two years of purchase, unless the property is the seller’s main home, has been inherited or transferred as a result of a relationship property settlement.
• A requirement for all purchasers of residential property, other than of the main home, to provide a New Zealand IRD number to Land Information New Zealand.
• A requirement for non-resident purchasers to have a New Zealand bank account and New Zealand IRD number.
• An extra $29 million for the IRD to fund compliance and enforcement.
The effect of the changes, which come into force from 1 October, will be twofold; one it will make it easier for the IRD to tax property speculators and two the Government will be able to collect more, and more useful, data about non-resident purchasers.
The “bright line” test is a clarification of the IRD’s current intention based test. Under the current rules, which will still hold regardless of timeframe, any gain from the sale of property which is purchased with the intention of making a gain is taxable at the seller’s marginal tax rate. The problem has often been proving intent.
Under the “bright line” test intention becomes irrelevant, at least for the first two years. If you buy and sell an investment property within two years, any gain on sale will be taxable as income. Subject to the few exemptions noted above, the IRD’s decision will be final and no correspondence will be entered into.
Critics have immediately identified the two year timeframe as a flaw that will be exploited by savvy investors who will merely hold on for two years and one day. What that ignores is that the current intention based rules still apply and the IRD will be getting an extra $29 million (on top of the extra $33 million it got last year) to enforce them.
Better data about non-resident purchasers will mean a clearer understanding of the impact non-resident purchasers are really having on the property market in New Zealand and pave the way for a withholding tax regime whereby the Crown can withhold tax at sale time from non-resident purchasers who sell within two years.
These measures are not the silver bullet that will take the heat out of house prices in Auckland, and the Prime Minister acknowledges that. Supply probably remains the best chance of addressing Auckland’s house price problems. But with investors (3), according to Shamubeel Eaqub of the New Zealand Institute of Economic Research, making 40%-50% of house purchases in Auckland these changes may make some difference.
What these measures really say is that the Government does see Auckland house prices as a problem and that they can’t rely solely on supply side measures to fix it. We think it’s a positive step and unlikely to be the last one.
In our next update about property in New Zealand we’ll write about the Reserve Bank’s efforts to “talk about Auckland”.
Scott Rainey is an Authorised Financial Adviser
Disclosure statement is free and available on request
Why the Government is Concerned About the Price of Property
Many investors that work with New Zealand Wealth’s member firms own residential and commercial property. Some of those people are entrepreneurs who know how to buy and sell property, and manage it effectively. By and large they work at it, and treat it professionally.
And then there are others that see it as a nearly risk-less asset class, with minimal management and little downside. This isn’t true, of course, but you wouldn’t know that looking at recent history.
Due to housing boom 1.0 (2000 – 2007) and housing boom 2.0 (2011 – 2013 and counting), generally – but not without exception – both groups have made money.
In most cases, the property they own has been financed by debt. Debt simply amplifies the gains and losses, meaning the good times are even better.
We’ve never been ones to forecast asset returns; in fact, we’re directly opposed to the practice. We do, however, look very closely at published studies, and recent studies requested by the New Zealand Government all point to one thing…the Government is concerned about the price of property.
Firstly, it’s a political football, and we all know it. The Government wants to appeal to the large and growing portion of New Zealand’s population that now rent, and can’t even afford starter homes.
But the problem runs deeper. As pointed out in the Savings Working Group report to the Finance Minister in 2011, New Zealand owes a lot of money to overseas lenders. The majority of this debt is not Government debt, but household debt. The report points out that, in the last 15 years, household debt has doubled (yes, doubled) relative to income.
They measure what New Zealand owes the rest of the world as a ratio of our productive output, or GDP. When measured this way, New Zealand finds itself in the neighbourhood of Portugal, Ireland, Greece, and Spain; the so called PIGS.
The report puts a good measure of the blame on high house prices; houses that require a lot of debt to purchase. Quoting the report, on page 8: “Much of this borrowing has been in the form of mortgages to buy increasingly expensive houses – both homes and rental properties.”
To complement this finding, in 2012 the Productivity Commission released a report on housing affordability. The report suggested several changes to Government policy to bring some stability to house prices. Suggestions included streamlining the consent process, opening up new land to housing, and changing policy on state housing. The report also highlighted potential changes to tax law, including a capital gains tax and the elimination of deductions for the inflation component of interest.
Martin Hawes, in a recent article, said: “Bill English has long talked about curbing house price inflation – I had a discussion with him on this as long ago as 1998. Next week’s budget may contain some things aimed at holding house prices down – Bill English gave a speech a couple of weeks ago which hinted at this and pointed to recommendations from the Productivity Commission.” (Quoted with permission.)
And in fact, Martin was right. In their recent budget, the Government included several measures aimed at holding down housing prices:
- Urgent legislation for ‘special housing areas’ that gives the Government the power to take control of housing planning and consent processes, if councils do not act quickly enough to free up land for houses
- Provision to fund ‘social’ as well as ‘state’ houses. Specifically, private sector groups will now be allowed to replace Housing New Zealand as providers of social housing
- Agreement with the Reserve Bank on measures to control house prices
- Inland Revenue will target $45m more tax from property investors
In reference to the urgent legislation, Housing Minister Nick Smith told the Herald that “Housing affordability has become so important that the Government is reserving the power to intervene.”
Again, we’re not forecasting what will happen to property prices, but this type of intervention shouldn’t be ignored.
Here’s the point: property investors should be wary, rather than expecting the good times to just keep on rolling. In the same way, any investor should be careful before looking at the recent past as prologue to the long term future.
This is not to say property cannot be a good investment. If you have the entrepreneurial spirit, treat it professionally, have available cash flow to develop and improve property, and the time and skill to spot deals, opportunities will continue to exist. Our nation, like most others, needs investors to continue to improve the quality and quantity of property. There’s a demand for it. But take heed of the risks before banking on big growth to make your investment worthwhile.