Why New Zealand needs a mind shift away from homeownership as Government releases its discussion document with regards to tax reforms around residential rentals

In March 2021, the Government announced a wide range of reforms with the goal of making residential properties more affordable for potential owner-occupiers. The reforms are highly controversial and, with regards to the removal of interest deductibility, hugely unpopular. The Government has released its discussion document with regards to the design of the interest limitation rule and additional bright-line rules and is inviting submissions on the proposals.

With that in mind, we have decided to put our own thoughts in writing and what we write here will be the basis of our submission. Although tax is probably not the most exciting of topics to write about, the significance of these proposals could have a detrimental effect not only on both landlords and tenants but also on the property management industry.

Landlords will be forced to aggressively increase rents whilst also potentially looking to either vacate the market or cut costs wherever they can, leading to fewer rental properties which will deteriorate due to a lack of maintenance as well as capital expenditure.

Flaws with the Government’s goal

The Government states within the discussion document that it wants to improve affordability for first home buyers by dampening investor demand[1]. However, this flies in the face of the Government’s actions who have reportedly purchased over 1000 homes from the private sector for public sector housing. This is housing that could have been purchased by first home buyers.

And since the radical announcement with regards to housing, what only appears to have happened is that the housing market has gone into its own lockdown with stock drying up leading to a huge shortage of property available for sale. The REINZ monthly report for May 2021 shows that housing inventory is at its lowest level ever with May listings dropping below 15,000 across New Zealand. This is only the second time this has happened since records began. Meanwhile, housing prices continue to hold. The median sales price for May 2021 is $820,000. This is a $200,000 increase from May 2020. So far, Government intervention has not had the desired effect.

Brad Olsen; Senior Economist for Infometrics
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The other aim that the Government has set out is to ensure that every New Zealand citizen has a safe, warm, dry, and affordable home to call their own, whether they are renters or owners.

From a tenant’s perspective, the interest deductibility rule is likely to have negative consequences. Tenants will be subjected to a more aggressive rental increase in an attempt by landlords to recover the losses they will be subjected to whilst landlords will look at cutting costs through maintenance and self-management. I do not see how this achieves the Government’s objective. So, if Government intervention fails what can be done?

The obvious thing to do is to increase supply, particularly of three-bedroom homes as this is what is always in the highest demand. However, this will take time and it will not be cheap. A lack of skilled labour, building materials and infrastructure means that it will be years before demand catches up with supply. The building industry already looks to be at maximum capacity.

The chances of the Government backtracking on its housing strategy are probably as likely as a cycle bridge being built across the Waitemata Harbour on time and under budget. It isn’t going to happen! My own opinion is that we need to work with what has been put on the table even if it does leave a sour taste in your mouth. I have no problem with the extension of the bright-line rules being extended from 5 to 10 years, in fact, I even like it. It means that more rental properties will be leased long term. Remember, the country needs rental properties and private landlords will house roughly 30% of the population.

It is the interest deductibility that most people, including myself, have serious misgivings about. It is hugely unfair and increases expenses on the landlord by as much as $100 per week which will lead to higher rents. As we have previously mentioned, there are no winners.

Why is homeownership such an important desire?

The reality is that many people who rent will not be able to buy a property, even with the Government measures being put in place. Infometrics economist Brad Olsen points out the house prices must drop by a whopping 55% or wages have to increase by 123% if we really want affordable housing[2]. That isn’t going to happen.

So why not reinvent renting?

Why do we have to aim for homeownership? Looking at my own circumstances, when we moved to Wellington 6 years ago from Palmerston North, I was nervous as hell doubling the size of my mortgage whilst starting a business with no guarantee of income. I sit here now wondering why I was so worried at the time. I do, however, worry about our future generations. Our kids will be paying around the region of $1 million for their first home which to me, is frightening. A mortgage of such size is a staggering amount of money. When interest rates do rise, servicing these mortgages will become increasingly challenging and that is bad news for everyone.

So why not make renting so desirable that people will look at alternative ways to build equity and wealth other than bricks and mortar?

Think differently. Long term tenancies the answers.

Let’s look at Germany as an example. In Germany, the average length of a tenancy is 11 years and nearly 50% of the population are tenants. In New Zealand, the average length of a tenancy is extending but it is still roughly less than 2 and half years with one-third of the population renting. If the Government’s aim is to have stability and security for tenants, then we have to think differently.

In Germany, nearly 50% of the population rent with the average length of a tenancy approximately 11 years

Our idea is to incentivize landlords to offer long term contracts to tenants whilst giving tenants the flexibility to give notice when their circumstances change, and they decide it is time to leave. If a landlord provides a tenant with, for example, a fixed-term tenancy for 10 years then they can be exempt from the interest deductibility rule.

Tenants will have a place that they can call home and establish roots in communities whilst their children will remain in the same schools with the same friends. This benefits New Zealand as a whole. The agreements will be written in a way that allows a tenant to give notice meaning that they do not have to pay break lease fees when they decide to leave.

Tenants are now already able to make minor changes to the property and with healthy homes standards being implemented, technically, there should be no issues with regards to tenants living in unhealthy conditions. These agreements will allow tenants to have pets and landlords will not be penalized with regards to interest deductibility meaning that there will be less pressure with regards to increasing rents and no need for cutting costs on maintenance.

Bonds can be replaced with tenants paying specialised tenant insurance which can protect them from accidental damage or temporarily support them if they find themselves in financial hardship due to losing their job or income. There will be no need to undertake intrusive three-monthly inspections which, in my opinion, are invasive and unnecessary, particularly if you have long term tenants who have a great record.

The purpose of this is to ensure that landlords are motivated to provide long term rental accommodation that fits the needs of both tenants and investors.

There are other things that the Government needs to consider with regards to the implication of the tax policy on housing

Exclude purpose-built rental accommodation from interest limitation rule

The current laws around interest deductibility are simply unfair as it particularly penalizes landlords who own multi-unit dwellings or student accommodation. These types of properties are not going to sell to first home buyers and essentially if you own these you are stuck with them as whoever purchases them will have to allocate roughly 30% of the rental income to tax from day one. Investors who own such properties should be exempt from the interest rule.

Allow interest deductibility on renovations

The Government’s policy hurts tenants in other ways. Landlords will simply have no incentive to do extensive renovations on their properties since any extension on their mortgages that they establish will automatically not be allowed to be offset against rental income. Therefore, more and more rental property will simply be let go and will not be maintained. This makes no sense at all when there is a huge push to get landlords to improve the quality of their stock.

Will the Government listen

When Grant Robinson announced the changes, he specifically used the terminology that landlords were speculators. Well, if you are offering a tenancy for 10 years, you can hardly be called a speculator. This will mean that rental properties are long term investments that will meet the needs of the tenants and landlords alike. Landlords will be incentivised to improve their properties increasing the quality of the product for the tenant. A win-win for all.

Most landlords are in it for the long haul, and they are a vital component of the housing structure of New Zealand. Rather than vilifying them as the problem, let’s look at how we can collectively get round a table and work together to find a solution.

[1] Design of the interest limitation rule and additional bright-line rules; A Government discussion document. Hon David Parker, Minister of Revenue

[2] Newshub report by Jenna Lynch 25th March 2021

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