Blog: The Landlord says...

Next week is shaping up to be fairly a interesting one for the housing market and where it is headed.

It’s not quite the big bang – that’ll be May 20 when the government unveils its new taxes in the Budget.

Rather, next week we see the latest house sales data from QV and REINZ, plus we have the next Official Cash Rate announcement from the Reserve Bank.

Anecdotal evidence we are hearing is that the housing market has slowed considerable, especially amongst investors.

There have also been reports floating around that a good number of investors are saying enough is enough. Let’s sell before the government destroys the market effectively taking away property investors’ retirement savings.

However, others are sitting tight waiting to see what happens.

The OCR announcement is a critical event to watch. While we are not expecting the governor, Alan Bollard, to increase the cash rate (like his counterpart across the Tasman did this week), we will be watching for a strong steer on where rates are heading. Or more precisely, we know they are heading up, we want an idea of when and how steeply they will rise.

There will be a point where borrowers enjoying these wonderfully low floating home loan rates will have to make a big decision.  Stay floating or move to a fixed rate? If it is the latter, the question becomes what term?

At the moment it looks like the shorter duration loans – out to around two years – will be the ones to go for. Longer term loans look pretty expensive right now, even though we have seen some decreases in the past couple of weeks.

So next week will be one to watch. While the data and news isn’t likely to spark huge amounts of activity, it will be fundamental information needed to plan future moves in the property market.

Property investors have been inundated with reactionary views on what the government plans to do to them through the tax system.

Now a bit of time has passed since Prime Minister John Key outlined the government’s plans to Parliament it’s worth reflecting on what might happen.

The first point is don’t be lulled into a false sense of security. Key dismissed some of the most distasteful ideas such as “comprehensive” capital gains tax, a land tax and a risk free rate of return method of taxing property.

You could almost hear the sighs of relief from investors.

What hasn’t been said though is what the government will do.

It’s pretty clear residential property investment has been singled out as the great evil which needs to be dealt to.

Apparently we all rort the system, pay no tax and are generally bludgers. What bunkum.

My views on this have been spelt out many times – the underlying premise being investors are business owners providing a service. They should be treated just the same as any other business owner and be subject to the same tax rules.

What’s on the cards?

Changes to depreciation for one. Property investors can live with that. After all it’s really just a timing issue and brings forward some revenue for the Crown.

What I wonder is this: Why the government should make a whole set of new tax rules?

It seems to me that Inland Revenue has had quite some success with its so-called Property Compliance Programme. Under the PCP it has been chasing investors who clearly have been buying properties and flicking them on for a profit.

So far they the programme has raised more than $214 million.

This is just the low-hanging fruit. Surely one option is to clarify the rules here and continue to enforce them.

Clarifying and enforcing these rules is something investors could live with too.

If the speculators’ activities could be curbed that would undoubtedly take some of the pressure off house prices. Particularly for those in lower price brackets.

The talk about changes to the tax system has died down a little and now reality is starting to sink in.

Most commentary has been around the fact that the proposed changes are designed to whack residential property investors. The anti-property brigade has been in strong voice once again pushing the spurious line all property investors are fat cats rorting the system; thankfully investors have been putting up a pretty good defence.

While things are still murky around what the government will do and how far it is prepared to go to alienate a good chunk of its support base, there is acceptance change will happen.

As I have digested the changes and talked to other investors it has become clear this is big.

Indeed I would argue the changes are once-in-a-generation stuff. The rules around residential property investing will totally change. The business will be totally different and investors will have to change their approach.

I have heard that many investors have got the heebie geebies and are already looking to exit and have put properties on the market.

I’m not sure that is necessary. The changes don’t necessarily mean that investing in residential property will no longer be profitable. It means you will need to think about how you approach it.

One change I suggest will happen is that some of these companies who find properties for investors and sell them to them on the basis of depreciation gains and tax benefits will struggle to survive.

Also the changes are likely to drive up rents over the medium term. While that is a plus for investors, tenants won’t be happy with the government.

The March issue of NZ Property Investor will be giving you lots more information about what these changes mean and what you can do adjust.

I’d love to hear your thoughts on the changes and how you plan to adjust to them. You can comment below or send an email to thelandlord@landlords.co.nz

PS: I was in Auckland this week and attended one of Kieran Trass’s breakfast presentations. He has plenty of views on the changes and also some ideas on what to do. If you are in Auckland and want to attend one of these Wednesday sessions click here.

Residential property investors have been a political target for some time now and today’s report from the Tax Working Group (TWG) made it clear they, unfairly, remain in the sights.

The TWG has put the acid on the government throughout the report and raised ideas which will be clearly more than the government can stomach.

The question that I struggle with is how far would a National-led government be prepared to go and clobber the property investment sector?

There is little doubt in my mind that the vast majority of property investors would vote National or some other party on the right of the political spectrum. To penalise several hundred thousand of its core supporters is the equivalent of political suicide.

National has plenty of political capital to burn, but moves such as the TWG have proposed are like lighting a bonfire.

I suspect there is some “low-hanging” fruit the government can pick. For instance the land tax idea is something that wouldn’t be too hard to do, and could raise a reasonable sum of money.

I am told there used to be a land tax (apparently it was a pink form filled out each year which had to be filed by the end of May).

Likewise changes to depreciation are possible. There is an argument which suggests depreciation isn’t really justified when the asset is generally appreciating. There maybe some instances, such as leaky buildings, where there is a genuine reason for depreciation, and the rules could be made to accommodate this.

Also an increase in GST would mean that property investors paid more tax.

One thing which was good to see is that the TWG didn’t get stuck into the argument about loss attributing qualifying companies. Many commentators have described this as a rort that property investors shamelessly exploit.

I have always had trouble with these arguments. The view being that property investors are in business providing a service (accommodation) to customers. They should be allowed to operate under the same rules as any other business. LAQC’s are legitimate structures for them to use.

This was summed up by the Institute of Chartered Accountants tax director, Craig Macalister, at www.netprophet.co.nz when he queried whether the current “emotion” around property investment was getting out of hand.

“We need to be careful not to fall into the trap of selected taxes for different assets or investments for all the reasons why these were a failure in the past,” he said.

The Reserve Bank governor threw a cat amongst the market pigeons this morning, defying predictions about when rates will rise.

Economists and the market have all been predicting that the Reserve Bank will have to back off its earlier predictions about rate hikes. Some even argued increases to the OCR could occur early in the New Year, rather than late in 2010.

Today they were right about one thing: the OCR was left at its historical low of 2.50%. Where they were wrong was with Bollard’s position that he sees no need to start tightening monetary policy soon and the increases are still some time in the second half of next year.

He made his views very clear in this part of his statement: “In contrast to current market pricing, we see no urgency to begin withdrawing monetary policy stimulus, and we expect to keep the OCR at the current level until the second half of 2010.”

Just for the record, current market pricing was saying there were expectations for a 100% chance of a 25 basis point hike in January and 200 points of hikes priced in over the next 12 months.

The central bank’s comments today will do nothing to stop the on-going increases to medium and long-term fixed rate home loans. The pricing of these mortgages comes off the back of what is happening overseas. Bollard and the Reserve Bank have no control over them.

However, today’s announcement will mean that variable rates stay low and, arguably, there could be some more downward pressure on them.

There is already a big variation in rate cards. In the competitive floating rate market the range is from BNZ’s 5.59% for its Total Money product, through to ANZ’s 6.45%. Added to this you need to look at revolving credit rates too as some lenders are using this product as its leading variable rate offer. Here the range is from Westpac’s 5.69% to 6.85% at HSBC.

Adding to the complexity of this market there are a number of lenders with more than one offering. ANZ has in the past month introduced what it calls its “Simple Variable” floating rate which has a few conditions attached, but is competitively priced at 5.69%.

The latest round of house price data clearly shows the market has a strong heart.

Overall prices are up, proving, as I long expected, that the bearish pundits were wrong. They said house prices would fall 30%. While I’m happy to see house prices and activity pick up again there are still plenty of obstacles facing the market.

The obvious one is tax changes – but I promised myself we would not talk tax this week – far too dirty. Instead, the biggest obstacle facing the market may be interest rates.

As our table shows, home loan rates have been rising strongly. Up until recently most of the changes were at the long end of the yield curve, now they are creeping right down to six-month fixed rates.

The only area immune from increase, it seems, are the floating rates. These and many revolving credit rates have been falling to quite low levels. It is clearly the part of the market with strong competition.

The range is from BNZ’s 5.59% for its Total Money product, through to ANZ’s 6.45%.

With revolving credit rates the range is from Westpac’s 5.69% to 6.85% at HSBC.

Adding to the complexity of this market there are a number of lenders with more than one offering. In the past month ANZ has introduced what it calls its “Simple Variable” floating rate which has a few conditions attached, but is competitively priced at 5.69%.

The concern for the property market and house prices is that expectations are building that the Reserve Bank will increase its official cash rate sooner than it has forecast.

There are also growing signs that when the increases come, they will be stronger and higher than many expect.

If this happens it will be like pouring cold water onto a property market that is starting to warm up. We will watch next week’s official cash rate announcement carefully.

We, the New Zealand Property Investors’ Federation are concerned about the high level of misinformation around taxation of property and the introduction of a capital gains tax (CGT).

The following is a reply to much of the misinformation and outlines why a CGT is not a magic bullet to solve New Zealand’s economic problems.

A CGT will not stop property price changes. Countries with a CGT have had at least the same level of property price increases as New Zealand, with many having greater increases. If anything, a CGT will increase property prices as vendors demand higher prices to offset the tax.

Rental property does not have a tax advantage over other investments or businesses. This was clearly confirmed in 2007 by Deputy Commissioner of Inland Revenue, Robin Oliver, when asked by a government select committee if there was some tax advantage for investments in rental housing.

“The short answer is there is none” was Oliver’s reply. “Rules about expenses for deducting costs such as interest, upkeep and maintenance, as well as paying tax on income, are the same for investments in shares or anything else. In fact under the housing case, the capital gains boundary is brought back a bit. There are tighter rules regarding what is a capital gain.”

With the exception of fund managers, anyone who generates an income through trading an asset (property, shares, gold, antiques etc) is taxed on the profit they make.

Property traders/developers/speculators are required to pay tax on profits they make through selling property. The IRD has been allocated over $14m to ensure that people in this sector pay the tax they owe and is achieving good results.

Anyone who sets up a business, buys shares or owns property primarily for long-term income, is not taxed on any capital gain they make. Therefore if a business owner sells his or her business and makes a $100,000 profit, this is not taxed. If a shareholder buys 100,000 shares for $1 and sells them for $2, they pay no tax. The same rule applies to rental property.

Many businesses make a loss during the first few years while getting established and rental property is no different. The rental market is extremely competitive and tenants enjoy lower rents because of this, helping them to save for a deposit on their own home.

The claim that rental property owners are somehow ripping off other tax payers and that a CGT would level the playing field is false.

A third point, often raised by CGT proponents, is that the rental industry is not part of the productive sector. This shows little understanding of what it takes to make a country productive.

Rental property owners house around a third of New Zealand’s workers. Without access to decent housing, these workers would be considerably less productive.

Rental property owners also contribute to the general economy through supporting banks, local councils, trades people, professionals, hardware stores, insurance companies and a host of other businesses.

It has been said that a CGT will allow a reduction of income tax.  This is an argument that may appeal to New Zealanders, especially high income earners who primarily invest in shares.

However any increase in tax revenue from a CGT is likely to be small. Overseas experience shows that a CGT does not raise a high level of tax dollars and is costly to administer. This means that any potential reduction in income tax levels is likely to be insignificant.

In addition, if a CGT is restricted to just rental property and excludes the family home, farms, businesses, shares and other types of investment, then the ability to collect enough tax to reduce income tax rates is even smaller.

Consider the tax losses that are currently being experienced by many rental property owners and the negative affect this would have on tax revenue should a CGT be introduced.

In summary, a CGT would not reduce property price increases and would not significantly increase the tax take. Rental property does not currently have a tax advantage over other businesses or investments, so a CGT would not create a level playing field – it would distort it.

Rental property is definitely part of the productive sector and to suggest otherwise is misleading.

Martin Evans is president of NZPIF

Property investors could well feel battered and bruised after many of the comments made in the media, following yesterday’s official cash rate announcement.

I’ll put it on the record now. Much of this property investor bashing is totally unwarranted. There is a perception, which is wrong in my view, that all these investors are hell-bent traders and speculators, buying and selling residential properties non-stop.

Wrong. The large majority of the investors we deal with through the NZ Property Investor Magazine and www.landlords.co.nz are conservative, buy-and-hold investors.

Some people chose to invest in shares, others prefer managed funds, while others go for cash and fixed interest. Many people have decided that property is their preferred means of saving and providing for their retirement. There are lots of reasons for this, and all of them quite valid. They range from the desire to hold something tangible they can see, touch and feel, through to having poor experiences in the sharemarket.

So I often come across investors who feel they have been unfairly castigated and discriminated against because of their choice of investment. Their view is at least they are doing something to plan for their retirement and aren’t relying in taxpayer-funded pension from the state.

Investing in property is not like some of the other asset classes. Yes, there are different tax rules and there are benefits like depreciation and gearing.

What seems to get lost in this debate is that these people are not only investors. They are running a business providing a service to fellow New Zealanders. Therefore, they quite rightly can use some of the same structures as business owners, such as loss attributing qualifying companies (LAQCs).

The other thing which surprises me is some of the comments about putting a capital gains tax on property investors. For the record, there already is one. The Inland Revenue Department is on a $15 million, three-year education and enforcement campaign to enforce this part of the law.

Already it has pulled in hundreds of millions of dollars in unpaid tax.

One comment I do agree with from Dr Bollard is this: He says New Zealanders should not consider housing investment to be a one-way bet. Investment expectations need to be realistic. We won’t go back to the boom times of the past eight years. However, in the long run, property prices, like those of other asset classes, tend to appreciate.

Next week we have more of the latest house price data coming out. These numbers are always eagerly awaited, but arguably more so this month.

Everyone wants to know whether the market has bottomed and is going to resume its upward trek or crash again.

As readers will know I have argued in favour of the market at least bottoming or maybe embarking on a slow upward recovery.

Not for one minute do I think we are heading back to the boom times again. Indeed as the lead story in the NZ Property Investor Magazine out next week warns, we are unlikely to see another boom period like the previous one.

The story suggests a back-to-the-future approach maybe the best strategy for investors.

My view continues to be that there are a bunch of factors, such as low interest rates, positive migration etc, which will put a foundation under house prices for now.

However I questioned my view when I looked at this chart prepared by ANZ and presented to the NZ Property Investors Federation conference.

The chart shows that if you believe in cycles and history then there is likely to be a further fall in house prices.

On the upside there are five periods where house prices rose, with the latest from 2002 to 2007 being the longest and strongest.

When house prices fell the downward periods lasted from 10 to 24 quarters and the falls ranged from 5% to 40%.

When you look at the strength of the last boom, prices rose 88% over 24 quarters, but have only fallen 16% over eight quarters then you could quite reasonably be expecting to see a further decline.

My guess though is that in this next round of house data releases we will see further gains. After all that is what the Barfoot and Thompson numbers showed earlier this week.

Optimism is returning to the residential housing market, which has some positive flow on effects to the economy as a whole.

This positive feeling is best shown in recent house sales reports which tend to indicate that we are past the low point of the cycle. From now on it will be a steady upward climb, although not steep.

It was useful to attend last week’s NZ Property Investors Federation Conference in Auckland to gauge the market.

You’d expect a group like this to be positive about things, and that did come through in talking to investors.

However, I couldn’t help feeling that the overall theme from speakers was to be cautious out there. The old cliché being we are not out of the woods yet. Indeed a very good presentation from the ANZ Bank left the clear message that some people may be getting ahead of the market.

Clearly the issues for investors are changing at the moment too. Earlier this year I wrote about finance being the biggest issue for investors. This is less of a problem now, and the biggest one is tenants and how to manage them.

The worst thing that can happen for a landlord is to have an empty property with no rent coming in each week.

I suspect with unemployment rising that this issue will continue to hang over the market for some time.

The message for landlords is that they have to really look after their tenants and keep a close eye on their bank account to make sure rent is being paid.

Too often I hear stories about investors not reacting soon enough when things go wrong. The rules are quite clear around what you can and can’t do, and there is plenty of information from organisations like the Department of Building and Housing and others to help investors. One of these is a series of seminars run by DBH to help landlords get it right.