Government policy, interest rates and house prices

This post will start with a little rant and then progress into trying to understand the downstream impacts of a big week for the housing market. Just in case you were under a rock this week, the government announced a major change in housing tax policy.

Let’s face it, we all knew something eventually had to give. It would take a bold, unpredicted move by government to finally bring the housing market back down to earth. And they didn’t disappoint.

If you prefer to watch and listen, here's JB talking us through it all:

The removal of interest deductibility came from left field

We can debate the merits of removing what would be a legitimate claimable expense for any other business activity.

Our Labour government had been posturing for ages, showing ongoing negativity towards property investors. It is a distorted view of property investors that has made them the scapegoat for bigger hard-to-solve problems. We have a narrative about the Rolls Royce driving property investor, but for the most part this couldn’t be further from the truth. Most investors I meet are hardworking kiwis chasing the dream of financial independence.

Whatever your point of view, the bigger problem is that a government can impose such a big policy change without analysing the downstream impact on the economy. For any government, or any business for that matter, this is simply reckless.

There is also a paradox in this for a Labour government

The proposed change will hit middle New Zealand where elections are won and lost. It is this constituency of hard-working (highly leveraged) kiwis that are the hardest hit, not ultra-rich property owners who don’t carry much debt. If anything, it will make it easier for the ultra-rich to accumulate even more property and at lower prices.

The ultra-rich own commercial property and land banks. Many are jumping into development chasing great yields and a tax distortion towards new builds will become a windfall. They don’t buy residential houses and they definitely don’t buy residential properties given the added burden of healthy homes or tenant friendly law. We talk about the 1 percenters, and this entrenches them even more.

Regular hard-working kiwis have been reprimanded by our government for investing in bricks-and-mortar. They are told to invest in business (aka the productive economy), which for most Kiwis is a motel or café. What a great investment that would have been over COVID!

What should we invest in? 

If you’re not buying a motel then your next best option is to put your hard earned money in the bank at a staggering 1.00% pa, or better still, put it in an overcooked share market which still resembles the wild west. I’m reminded that the share market was invented by the rich to legally steal from the middleclass. And if you think I’m joking, look at the recent run of failed IPOs.

And whilst it set out to burn effigies of cardigan wearing property investors, Labour’s housing policy last week still didn’t address the fundamental issue of affordability. Roughly half of our population cannot afford to buy a house, and nothing announced last week changes that.

Many Kiwis don’t have the discretionary income even with benefits like working for families and accommodation allowance to be able to borrow enough to buy a home. And if they cannot buy a home, who will provide them with one now that property investors are in purgatory? And at what cost?

The real winners in our economy are those that can get government contracts or sell to the government. Most of our rich listers got their start doing backroom deals with the public purse. There is a distinct lack of contestability, accountability, and transparency that comes with money doled out by our government.

So giving Kāinga Ora a wave of money is guaranteed to fail.

I heard of them recently paying about 30% more for land than a private developer was willing to pay. From what I see, this kind of malinvestment is endemic in all forms of government. One of the widely known games in town is getting Kāinga Ora signing up to long-term leases with high rents on new to-be-developed boarding houses, or hotel or motel conversions.

Ok, rant over.

I figure that the removal of tax deductibility will have a material impact on property investment. Most property investors aren’t cash rich and many are small business owners. In my opinion, bank economists are underestimating the impact just as they overplayed the impact of COVID. Once bitten, twice shy.

For a number of small investors, the cash flow impact will be too high for them to manage and they will eventually be forced to sell properties. In the short term, they will stop buying and that will reduce competition with first home buyers. In the medium term they will start selling and there will be even less buyers.

This is great for first home buyers who are looking to buy into areas that investors are looking to sell.

In places like South Auckland, those renting cannot afford to buy.

Less buyers and less competition for houses will reduce prices, or at the very least reduce price pressure. Less availability of rentals will push up rents and push renters into lower socio parts of Manukau. The cost of this polarization between those that can own and those that can’t will play out in the traditional rental suburbs and lower socio areas scattered around our cities.

There is also the impact of bank credit policy to consider. Banks assess affordability on pre-tax rental income whereas going forward they will need to assess on post-tax income (effectively 33% less rental income). This is likely to tip the majority of investors into ‘negative-servicing’ which has a multitude of impacts.

Firstly, less investors will be able to buy

Second, when selling properties with negative servicing the banks are likely to take full proceeds of sale to reduce debt. That’s fine as long as the funds were not required elsewhere. In other words, it could create a cash flow crunch.

A large number of New Zealand small business owners are property investors, so a cash flow crunch on property investors is actually a cash flow crunch on small business. Oops – the unintended consequences of rushed policy. And the impact will be felt the hardest in middle New Zealand.

As I’ve already said, it doesn’t solve the issue of affordability.

That requires a focus on the extortionate and ludicrous cost of building which is too hard for Government and councils to fathom given they are a major contributor to our abysmal productivity.

The saving grace for investors right now, is very low interest rates

Most long-term investment property is already cash flow positive due to increasing rents, higher prices and extraordinarily low mortgage rates. And that is a strong mitigant against any larger negative impact on the property market.

What it does mean is that the Reserve Bank is now likely to keep interest rates low for longer. Long term wholesale rates fell this week as the market started digesting the policy implications. Don’t feel compelled to rush out and fix for too long.

The new housing policy will also take the pressure off LVR restrictions, so I’m expecting to see these ease up again as heat dissipates from the market. The government applying a fiscal ‘tax’ tool will take the pressure off our Reserve Bank having to carry the burden through macro-prudential tools.

So, the good news for first home buyers is less competition, easier credit, and low mortgages rates for longer.

However, there will still be a shortage of property is good locations. A lot of the price pressure in these locations has come from developers looking to build infill terraced housing who have been incorrectly labelled as property investors. We are likely to see a continuation of this trend especially with the tax distortion towards building new terraced houses.

I have an inkling that last week’s policy is going to create as many problems as it solves. If you’re wanting to buy in a desirable part of any city, I wouldn’t hold my breath that prices will fall.

If you are a highly leveraged property investor, tread carefully and don’t put your head in the sand. There are undoubtedly speed bumps ahead.

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