Tax changes in NZ likely to result in falling property prices and higher rents, it is claimed

Tax changes, rising interest rates and a falling population are all predicted to contribute to the contraction of the country’s real estate market with prices already down 12% from their peak in 2007.
 
Tax changes due to take effect on October 1 are one of the main influencing factors in reducing the fundamental value of houses, creating a renewed reason to expect continued price weakness, says Westpac economist Dominick Stephens.
 
The biggest impact will be from the lowering of the top personal income tax rate from 39 to 33%. The tax laws allow landlords to use cash losses on property investments to offset other sources of taxable income, while capital gains are usually untaxed. Lowering tax rates reduces the value of that tax shelter, he explained.
 
Owner-occupiers also avoid tax in the sense that any other investment would incur income tax on the flow of benefits. ‘The tax cut will improve the return on alternative investments relative to buying a bigger or better house,’ Stephens said.
 
In comparison the removal of a depreciation allowance on buildings is much less significant.
It would seriously hurt the cash flow of a few highly leveraged property investors, Stephens said, but because landlords have to pay back depreciation claims upon sale, unless the property actually does fall in value, for most of them the tax change only meant the loss of an interest free loan.
 
Westpac estimates house price inflation will be about 10% less over the next few years than it would have been without the tax changes.
 
They also expect rent to rise by about 7% more than they would have been had the tax system remained unchanged but it will take years for these changes to work through the market.
 
Another effect of the tax changes is expected to be a widening of the gap between low and high end properties. This is because landlords, more sensitive to tax, are more active towards the lower end of the market, while the potential buyers of upmarket properties get the biggest tax cuts.
 
Stephens expects the decade ahead to look more like the 1990s, when tax changes were unfavourable to landlords and favourable to those on high incomes, in contrast to the 2000s when the introduction of the 39% top tax rate both hit those on higher pay and increased the incentive to buy rental properties.
 
The recovery in the housing market last year may have been partly caused by buyers rushing in while mortgage rates were low but now that floating rates are on a rising trend, buyers seem more reluctant, he added.
 
Westpac expects floating mortgage rates to rise steadily, to a ‘new normal’ level higher than that of the 2000s. Global interest rates are expected to be higher, pushing up banks’ funding costs, and higher average mortgage rates are tipped to reduce demand.