Industry commentary

New tax bill passes: has New Zealand housing lost its appeal?

 

On 17 March, New Zealand Parliament formally passed a controversial bill abolishing the longstanding policy allowing interest deductions on rental properties. New Zealand is among the few OECD countries without a capital gains tax, but implementing this legislation essentially amounts to a loosely structured, indirect capital gains tax.

To address runaway house prices, the Labour Government announced plans as early as March last year to reform the tax system and remove the preferential treatment enjoyed by property investors.

Alongside tax reform, the New Zealand Government has extended the bright-line test period. Under the latest rules, properties purchased after 27 March 2021 are subject to a 10-year bright-line period. This means owners selling residential properties held for less than 10 years must pay tax on the gains, with an exception for their main home.

Finance Minister Grant Robertson said the passage of the Taxation (Annual Rates for 2021–22, GST, and Remedial Matters) Bill aimed to curb investor demand while encouraging the supply of new homes. He said: “We want to create a level playing field so first-home buyers can get onto the property ladder, while ensuring we do not put obstacles in the way of supply.”

It is worth highlighting that the legislation includes exemptions: commercial land, property developers and new builds, for example, will not be subject to these rules.

The specific provisions are as follows:

For residential properties purchased on or after 27 March 2021, interest deductions will no longer be available from 1 October 2021.

For properties purchased before 27 March 2021, the amount landlords can deduct will be gradually reduced over the coming years:

From 1 October 2021 to 31 March 2023, 75% of interest can be deducted;

From 1 April 2023 to 31 March 2024, 50% of interest can be deducted;

From 1 April 2024 to 31 March 2025, 25% of interest can be deducted;

After 1 April 2025, interest deductibility will be abolished entirely. This means landlords will be unable to deduct any interest expenses from rental income in the 2025–2026 financial year or subsequent financial years.

 

An industry perspective:

Frank Xu

President of the New Zealand Chinese Building Industry Association

YIJU: Do you think the tax reforms will significantly increase investors’ property holding costs?

Frank：They will certainly increase the cost of holding rental properties, particularly for short-term investors and those who bought existing homes after 27 March 2020. Over the next three to four years, investment property owners’ holding costs will definitely keep rising.

YIJU: Will the new rules encourage landlords to pass these costs on to tenants?

Frank：There is almost no doubt about that. Rental property investors need to strike a balance: either find savings elsewhere to offset these costs or pass them on to tenants.

YIJU: Will these rules make property investment less attractive?

Frank：I do not think these new rules will fundamentally reduce the appeal of investment properties. Auckland’s average house price now exceeds NZ$1,000,000, with annual price growth of between 5% and 7%. Conservatively speaking, a property gains between NZ$50,000 and NZ$70,000 in value each year. The new tax policy we have just discussed actually adds only a few thousand New Zealand dollars in annual expenses, which is negligible compared with tens of thousands in capital gains.

YIJU: What advice do you have for rental property investors?

Frank：I believe most rental property investors already have a strategy. First, I suggest replacing their existing homes with new builds, as new builds are exempt from the new rules and interest remains deductible. There are many new townhouse developments on the market. Their smaller size and new condition make them more attractive to tenants.

Second, change the investment mix. Interest remains deductible for commercial properties and new builds. Investors can minimise borrowing costs by holding a combination of new builds and existing homes, new builds and commercial properties, or existing homes and commercial properties.

 

As inflation continues to soar, is New Zealand commercial property still an effective hedge?

 

In June, the New Zealand arm of global commercial property services and investment firm CBRE released a report titled Inflation, Interest Rates & the Property Market. It examined the broader environment and outlook for inflation and lending rates in New Zealand, their implications for New Zealand commercial property, and forecast investment performance across market sectors:

Inflation and lending rates in New Zealand

New Zealand’s inflation rate reached 6.9% in the first quarter of 2022, its highest level since 1990. Businesses and consumers alike expressed concern about the future, with cost expectations, pricing intentions and inflation expectations at or near long-term historical highs.

CBRE forecasts that New Zealand inflation is likely to peak around the middle of 2022, based on the Reserve Bank of New Zealand (RBNZ) continuing to raise short-term interest rates aggressively; The official cash rate (OCR) will peak in mid-to-late 2023, with a further increase of 150–200 basis points. Interest rate swaps (IRS) and bond yields will peak at the end of 2022, 25–50 basis points above current rates. This means only moderate upward pressure on fixed rates, potentially beginning to ease in 2023.

The impact of inflation on commercial property investment returns

• There is no particularly direct relationship between inflation and property investment returns.
• The indirect negative effects stem from the link between inflation and lending rates, which largely depends on the balance between GDP growth and inflation, and on supply and demand fundamentals. Higher interest rates raise debt costs, affecting commercial property investment returns. Rising financing costs also erode the value of the property itself.
• For commercial tenants, the general expectation is that rent, as a business expense, will rise with inflation alongside other costs.
• Lease terms are crucial: provisions allowing CPI-linked rent reviews support rent increases, particularly for shopping centres, prime offices and industrial premises.
• Rising construction costs may mean fewer new developments, supporting occupancy and rents. Higher construction costs also drive up rents for new developments, lifting rents across the commercial property market.
• Capital returns are highly sensitive to changes in lending rates, but income growth and investor sentiment can outweigh the effect of lending rates on capital returns.

Commercial property: impacts and outlook

• Overall, the outlook for the balance between supply and demand provides a positive foundation for rental income growth. Secondary CBD offices are an exception, with vacancy and rental pressures expected to persist.
• Commercial property rental yields remain relatively attractive, but pressure from higher lending rates is gradually becoming apparent for investors who rely more heavily on borrowing.
• Investors currently favour strategies focused on stable, predictable and growing income. Capital will flow towards sectors and submarkets with these attributes, which will remain more resilient in pricing terms. Conversely, sectors and assets lacking these attributes will face greater price discounts.
• Pressure on capital returns from lending rates appears temporary, with the interest rate outlook suggesting it may dissipate in 2023. In the current environment, investors less dependent on financing may begin to improve liquidity, viewing the current market stalemate as an opportunity.

 

An industry perspective:

Bernard Leung 

In 2001, Bernard Leung bought his first New Zealand property at the age of 21. He has since been active in the property market for 20 years and is a well-known property investment expert and experienced residential and commercial property manager.

In this CBRE report on inflation, interest rates and their effects on the property market, property is regarded as an effective inflation hedge. Even so, as inflationary pressures intensify and the Reserve Bank of New Zealand and markets respond to rising interest rates, attention has increasingly turned to how this inflation cycle may affect the property market.

This attention helps explain why inflation became one of the most hotly debated public issues in the first half of 2022. People are asking: how will inflation play out in the commercial property market? The future is full of uncertainty.

My reading of the report leads me to the following views:

After two years of subdued overseas investment, New Zealand’s commercial property market is expected to see a surge over the coming months. As New Zealand’s borders reopen, office assets will attract more capital investment.

The logistics and industrial property markets in Auckland, Wellington and Christchurch remain the most active. Limited stock, constrained development opportunities and strong demand will continue to drive industrial rents higher.

Inflation is directly affecting costs, and commercial property costs are being reflected in rising rents, particularly for new developments. This will put upward pressure on the rental market over the next 12 months. Rents are rising noticeably and could reach NZ$900 per square metre by 2024.

 

Draft MDRS rules released: who stands to benefit from the opportunity?

 

In October last year, the Labour Government and National Party jointly announced new housing construction legislation, the Housing Supply Bill. Its new concept of Medium Density Residential Standards (MDRS) was seen as supplementing the Auckland Unitary Plan and the National Policy Statement on Urban Development (NPS-UD), attracting widespread attention across New Zealand.

On 19 April, the long-awaited draft planning rules combining the MDRS and NPS-UD were finally released for public consultation. This means medium- and high-density housing rules will apply across most of Auckland in the near future, bringing changes to zoning rules and design requirements for medium- and high-density housing.

The draft planning rules propose a focus on unlocking high-density development potential in central urban areas: allowing developments of at least 6 storeys within a 15-minute walk of the city centre; applying high-density planning provisions within a 10-minute walk of train and bus stations in 10 metropolitan centres (Newmarket, Manukau, New Lynn, Sylvia Park, Botany, Papakura, Takapuna, Henderson, Albany and Westgate); increasing density around larger town centres with good public transport access; and providing for Terrace Housing and Apartment Buildings zones within 400 metres of larger urban centres and 200 metres of smaller town centres.

The draft design rules also include several changes worth noting:

• Building 3 or fewer homes on a site will no longer require resource consent (RC); buildings may be up to 12 metres high and a maximum of 3 storeys;
• Height-in-relation-to-boundary restrictions are relaxed, changing from the proposed 6 metres plus 60° to 4 metres plus 60° (an angle of 60° starting 4 metres above the boundary);
• Building coverage increases to 50%;
• Living room outlook space changes to 4 × 4 metres, while outlook space for all bedrooms is 1 × 1 metres;
• Outdoor living space must be at least 20 square metres;
• Street-facing glazed doors and windows must cover at least 20% of the front façade, and landscaped area must be at least 20%;
• The front setback from the street boundary is 1.5 metres, with setbacks of 1 metre from other boundaries.