Rental property tax treatment helped inflate property values - OECD

These are among the conclusions in the OECD Economic Survey of New Zealand, which includes a number of wide ranging observations about the New Zealand property market.

While the report said the Government addressed some of the issues in the 2010-11 Budget, "Introducing a comprehensive realisation-based tax on capital gains would further reduce the bias towards housing investment relative to other assets."

The report calls for the favourable tax treatment of housing and inefficient regulatory constraints on supply to be reformed.

"These distortions exaggerated the surge in house prices, giving rise to wider wealth inequalities and a heavy dependence of households' long-term financial positions on volatile property values. Despite the slump in housing demand, property prices remain at high levels relative to rents and average incomes, keeping affordability low for less affluent households."

Allied to this distortion the OECD claims relatively shallow capital markets also contribute to the attractiveness of housing as a savings vehicle relative to financial assets.

The OECD said that while some progress had been made regarding tax distortions and inefficient delivery of social housing, "policy priorities should include further tax reforms to level the playing field for saving and investment decisions, while improving the efficiency of land-use policies and the overall urban planning system."

The OECD said the New Zealand property boom which began in the early 2000's, while fuelled by demand-side factors such as easy credit financed from abroad and migratory inflows, was exacerbated by restrictions on new housing supply and tax advantages to rental property purchases.

"As a result, the increase in house price was larger than in most other OECD countries."

While there had been some adjustment since the middle of 2007, the report said prices remain "historically very high relative to incomes and rents."

"Wealth gains have accrued primarily to property owners, whereas the proportion of households unable to afford to buy a home grew significantly."

The OECD also claimed that New Zealand, unlike other advanced economies, had a greater concentration of household wealth concentrated in property and land assets - "in part because unrealistic capital gains expectations raise the perceived returns to real estate investment relative to alternative assets for long-term wealth creation."

The OECD report also warns against this savings imbalance towards property.

"International experience has shown that real estate returns are highly variable over time, and thus the long-term financial positions of New Zealand households are subject to substantial undiversified risk."