The goalposts have shifted, again. The Government extension of the bright-line test to 10 years, coupled with the removal of investors’ ability to offset their mortgage interest payments against rent received, marks the latest instalment in a seemingly endless succession of changes to property investment law.

It’s been met with shock and outrage from many. There are fears that “mum and dad” investors will no longer be able to afford to keep their retirement dreams alive, as thousands of dollars are added to their annual expenditure.

Aimed at addressing the vertiginous rise of property prices since the removal of LVRs last year (due to fears around a bottom out after Covid-19), these measures come in the wake of increases in LVRs, which moved to 30% on March 1, increasing to 40% on May 1.

New Zealand Property Investor undertook a survey shortly after the changes were announced. The results were enlightening: 54% believed that the changes would slow down house price growth, and (interestingly) 54% said they supported the extension of the bright- line test to 10 years.

Nearly 67% said that the changes wouldn’t lead them to sell their property; but 45.2% said the changes would lead to them putting up rents, neck-and-neck with the 43.9% who said they would do nothing.

But what are the real implications of these changes? And are they likely to make a significant difference when it comes to housing prices or the number of investors buying in the New Zealand residential property market?

Nuts And Bolts

The details of the changes made in March have been well publicised, but here’s a rundown.

From March 27, the bright-line test was extended to 10 years. This means that any investment property bought on or after that date will be subject to taxation on capital gains, which could be anything up to 39% depending on income and the amount the property sold for.

The removal of interest deductibility from investment properties has been the biggy for most investors. This does not apply to existing properties, only to properties bought after March 27. Those with existing mortgages will have the interest deductibility phased out over the next five years, coming into full effect on April 1, 2025.

It’s this change that has raised the ire of many in the property investment industry. It will affect investors in a real sense at tax time, adding potential thousands to what they will owe IRD at the completion of each tax year.

Matthew Gilligan, managing director of property accountancy firm GRA, presented his calculation around the real costs of the changes on a webinar filmed after the announcement.

In his analysis on a home valued at $750,000, the status quo after all expenses would see the investor receive $3,685 after tax on an existing property. Once the deductibility is fully removed (for an existing property this will be 2025) the end position will be negative cashflow of $3,740, a net tax cost of non-deductible income of $7,425.

For those with not much to come and go on, this could have a big impact.

“If interest rates go up, then the fullcost is passed through to the investor ,with no tax relief. If the Reserve Bank forces investors on to principal and interest loans, it will be much worse,” says Gilligan.

Making It Work

If we are to take our survey results at face value, most investors are committed to riding out the current storm. But changes will have to be made. Andrew King, president of New Zealand Property Investors Federation, is one of the many commentators who believe that investors will try to recoup their losses through rent rises.

“When there is capital gain to be had, rent prices can be kept low,” he says. “But with the introduction of the ten year bright-line test, it changes the whole dynamic of the business.”

He believes that the moves have been unnecessary, as the upward trend experienced late 2020 and early 2021 was about to plateau.

“If you look at cycles in the property market, there is often a sharp increase followed by a breather. Indications are that this was about to happen anyway.”

Mortgage brokers have been reporting that investors were buying up before the reintroduction of the LVR limits: and that the growth would have likely abated in a few months.

“The [Government] hasn’t done the research and taken a wider look,”says King. “The prices were going to drop anyway.”

New Builds On The Up

New builds are exempt from the 10 year bright-line test (this will stay at the current five-year level). There will also be consultation around whether new builds will be exempt from the tax deductibility change. But given the lower LVRs for investors on new builds, and the ability to deposit then pay a few years later (as is the case with off-the-plan developments) there is an incentive incentive to move in this direction.

“I definitely think there is a strong incentive for investment in new builds,” says CoreLogic’s senior property economist Kelvin Davidson."

David Windler from The Mortgage Supply Company says that off-the-plan and new-build options are becoming increasingly attractive.

“This is quite often a solution prompted by us when we measure up the investor’s options to understand the
useable equity,” he says.

With a 40% LVR looming (and already in place for many lenders) the 20% LVR in place for new builds and off-the-plan developments is becoming a sound option. And Windler says that banks are looking more favourably at off the plan.

“The banks were looking at the risk positions last year when there was a lot of uncertainty around Covid-19,” he says. This led to some wariness on the part of lenders.

But as the property market defied all predictions and soared, banks have become more likely to lend for an off-the-plan investment. With many new builds presold, off-the-plan is likely to increase in popularity.

What Next?

Independent economist Tony Alexander and the New Zealand Property Investors Federation have both run surveys since the announcement of changes to property investment rules. Alongside the survey run by New Zealand Property Investor magazine, these provide a useful snapshot of investor sentiment and point towards potential changes in the market.

Tony Alexander’s survey of over 3,600 investors revealed that most investors supported the Government’s aim of improving access to home ownership for first home buyers (69%). However, 75% of respondents replied that they will be negatively affected by the rule changes, 74% said raising the rents more than they intended to is their only option.

Other responses to these changes included: not buying another property as previously planned (32%); seeking higher paying tenants (29%); cutting on spending on themselves to offset reduced net renting cashflows (25%) and switching to alternative investments (23%).

Alexander also found, “A number of people noted that because of the change they would have to abandon their previous policy of not matching market rents because they wanted to retain their preferred tenants.”

New Zealand Property Federation’s survey around the changes to residential property indicate that many investors will be stung by the changes. A whopping 90% of respondents said that they would be affected by the interest deductibility changes, whereas 69.2% of investors said the bright-line extension would have “no effect” on their investment portfolio.

Most of the respondents 1,719 (70.3%) claimed that they currently charged under market rent for their properties. The respondents owned an average of 5.3 homes each, at an average value of $609,407. Taking this as a starting point, the average increase in tax from the removal of mortgage deductibility was $3,140.

In order to compensate for this rise, 78.8% of investors said they would increase or probably increase their rent. Most would not consider selling, just 21% said they would consider selling.

Business As Usual

Davidson says that, despite the predictions of some pundits, he does not anticipate that there will be a wholesale sell-off of investment properties. And he believes that most investors will still be in the game once the dust settles.

“There is still quite an incentive to avoid the bright-line test. There’s also the question of where to put your money, with bank interest rates so low,” he says.

He believes that some people may try to push rent rises through, but questions how successful this will be.

“Rent rises usually run with wage growth. There is a risk if people put up rents too much, they might lose good tenants. And even a few weeks with an empty house will hit investors hard.”

While he concurs that there may be a slight slowdown in price increases, he thinks the latest changes will soon be seen in the context of usual market ebbs and flows.

“While there are still such low interest rates, I don’t think we will see much of a slowdown in investor activity.”