Investor demand has been a major booster of house prices, he says.

The proportion of bank mortgage lending to investors has remained essentially unchanged over the past
four years.

“In the existing low interest rate environment, investors’ search for yield and capital gains on rental properties has underpinned rapid increases in house prices, but the Government’s plans to scrap mortgage interest deductibility against rental income is going to significantly reduce the prices investors are willing to pay for houses,” says Ranchhod.

Westpac’s economists have frequently highlighted financial considerations, such as rental yields, mortgage rates and tax, play a bigger role in determining what prospective buyers will pay for housing than physical factors such as supply.

Up until now, says Ranchhod, the tax treatment of mortgage interest costs has given leveraged property investors “somewhat of an edge” over owner-occupiers.

However, removing the deductibility will dramatically lower the yield on rental properties and the changes to the tax system will dramatically tilt financial conditions in favour of owner-occupiers.

A rough calculation by Westpac’s economists indicates owner occupiers’ average willingness to pay is about 10% below existing prices, which suggests house prices could eventually fall by that much in the long term.

While that will be a big drop, it will only bring prices back to where they were four months ago.

Independent economist Tony Alexander says investors have an established history of becoming concerned whenever the government makes changes which negatively affect them. Yet there are really no other options for investment in the current low-rate environment, which means that there is unlikely to be a large sell off.

“The thought of selling then having the cash sit in the bank will be a strong brake on the willingness of many to quit their housing asset this year and next.”

He does concur that this time things could be a bit different given the lumping of the tax change on top of increased expenses related to Healthy Homes, ring-fencing of losses, and decreased ability by investors to
manage their property.

“It is highly likely in the next few years there will be a structural decline in the proportion of the housing stock owned by investors, but a structural rise in their proportion of new builds. Alongside that there will be a structural improvement in the quality of rental accommodation and security of tenure for tenants, higher average rents and a pushing out to the state sector of tenants considered lessdesirable by the personal criteria of the property owners.”