INSIGHTS

Last week's announcements from the Government about proposed housing policy changes were significant, especially the removal of interest deductibility.

The extension of the bright-line test from five to ten years was largely expected, but few predicted that property investors would no longer be able to write off interest costs when calculating their tax.

This will have a genuine impact on the returns many investors can generate from their investment properties, effectively adding another layer of costs (by increasing the tax burden quite substantially).

Those with substantial debt against their rental properties will be most affected, while owner-occupiers and those with no mortgage debt will see no change.

I’ve personally got no issue with these moves. They might take some heat out of the market and incentivise people to expand their investment horizons beyond houses.

Then again, I would say that. The industry I work in would be a direct beneficiary of landlords selling up and reinvesting elsewhere.

That’s been an increasing trend in recent years anyway, with many investors opting for the hands-off nature of shares and fixed income, as well as the ease of diversification, higher liquidity, and similarly attractive (or in many cases, higher) returns.

It’s only those with a penchant for high leverage and debt levels that seem to be solely focused on rental property these days.

Even though I agree with what the Government is trying to achieve in principle, I didn’t like the way it was labelled as “closing a loophole”.

There’s no loophole to close. Interest has always been considered a cost of doing business, just like legal fees, rates or insurance.

The deductibility of interest has never been limited to rental property investors either. If one takes out a loan to invest in dividend paying shares, that interest is also tax deductible, and will remain so.

It’s not the closing of a loophole, it’s simply an abrupt changing of the rules.

Whether this change causes an outright decline in house prices remains to be seen. It could, although we should remember that the demand/supply imbalance remains supportive of the housing market overall.

Having said that, it is almost certain that price increases from here on will now be more subdued.

The return equation for investors simply doesn’t look as good anymore, so one would think demand will decrease to some degree.

Some existing landlords may choose to exit the market or reduce the size of their portfolio to pay down debt levels, while others will attempt to increase rents to cover the shortfall.

As a result (and somewhat counter productively), the impact of these new policies could be that further pressure is imposed on renters.

In terms of the economy, a more sombre outlook for house prices will mean reduced economic activity in some sectors and lower consumer spending (because of a reduced wealth effect from homeowners).

Lower growth and inflation means there is less pressure on the Reserve Bank to rein in its current stimulatory monetary policy, so it points to a lower for longer interest rate track.

Unsurprisingly, we saw longer-term interest rates (as well as the NZ dollar) fall in response to these announcements.

Finally, because the changes to interest deductibility came as a bit of a shock, it’s important the Government assures the wider business community there are no major changes looming elsewhere, and that it is the housing market specifically that is under the microscope.