No quick fix for housing crisis, no matter the announcement

The recent government’s announcement on housing has introduced substantial changes into an area of the economy where issues are readily identified, but solutions are less obvious, and notoriously hard to implement. With both supply and demand-side changes now underway, concerns have emerged over just what impact the policies together will have, and if they will fix the housing market.

Although the housing package is a good start, it won’t fully fix underlying issues, and sustained actions are needed to address New Zealand’s housing crisis.

A six-point plan to address housing crisis

Home ownership rates have fallen further in recent years. House prices in February 2021 were sitting 21.5% higher than a year ago, according to the REINZ House Price index. The state housing waitlist has increased to over 22,000 households. Warning signs for the housing market have been flashing red for months, and the political, economic, and social need to address them had reached tipping point.

Late March’s government announcement saw a six-point plan to address the red-hot housing market. The plan includes:

Supply-side changes

  • A $3.8b Housing Acceleration Fund (HAF) to free up “build-ready” land
  • An additional $2b borrowing allowance for Kāinga Ora for land acquisitions
  • An extension of the Apprenticeship Boost initiative to increase worker numbers

Demand-side changes

  • Increases to price and incomes caps for the First Home Grant
  • An extension of the bright-line test (for tax on housing capital gains) to 10 years (with an exemption for new builds)
  • The removal of interest deductibility for current and future investors.

Taken together, the housing package policies are designed to screw the scrum away from investors and simultaneously towards first home buyers as a short-term fix. Longer term, additional housing supply enabled by the HAF is expected to address the undersupply of housing across New Zealand. In many regards, investors were the “losers” from the housing package, but there weren’t any firm winners. First home buyers didn’t get hit, so didn’t lose, but house prices aren’t suddenly affordability or available, so they didn’t really win, either.

How will the package change things?

Each policy changes things, with some intended, and unintended, consequences.

Housing Acceleration Fund

The $3.8b Housing Acceleration Fund addresses issues made clear in recent years that councils, iwi, and developers have faced difficulty in accessing buildable land due to the cost, or who bears the cost, of infrastructure. Without services, it’s not worth building any new dwellings, which has in part limited the ability to bring more houses online. More importantly, the lack of developable land has kept land prices rising and seen the pipeline of activity more limited as developers want to build but can’t find a place to locate their investments.

The $3.8b investment is both a lot, and too little, funding. Too little because of the scale of infrastructure investment needed across New Zealand. A recent Department of Internal Affairs estimate shows $110b is needed over the next 30-40 years to fix the country’s water systems alone. But the Fund is also a lot, given that the government has struggled to deliver housing- and infrastructure-related investments in recent times. KiwiBuild needs no further analysis, and the Shovel-Ready projects programme is off to a very slow start.

Apprenticeship Boost extension

New Zealand’s closed borders and expectations of lower skilled migrant levels post-COVID mean that the construction sector will be one of many areas that will need an increased focus on a local workforce. Continuing support for apprentices is an important element of this task, with the scheme both adding new talent into the sector, but also formalising and upskilling current workers to improve and increase their productivity and output.

Increased First Home Grant caps

Increased income and (some) regional price caps will increase the eligibility for the government’s First Home Grant (and Loan) scheme. However, without increasing supply, the increased support for first home buyers is really just a subsidy for current sellers, who can push their prices higher in the knowledge that there is a buffer between what a new buyer can pay and what the additional support they can receive from the government.

To arrive at the new caps, the government’s calculations are technically correct but less practical than they seem. The price caps are based on the median of lower quartile prices, even when lower quartile properties are often investor-focused and include properties with higher deposit requirements including apartments and buildings in need of repair. First home buyers generally buy somewhere between the lower quartile and the median. REINZ analysis for Newsroom found that less than 500 additional properties would become eligible, based of previous sales in the last year, under the changes in Auckland and Wellington.

Extension of the bright-line test to 10 years

The extension of the bright-line test to 10 years was well picked in the lead-up to the announcement. The extension sees tax paid on capital gains for properties sold within 10 years of purchase. In effect, this extension makes the bright-line test a capital gains tax in fall but name (albeit on a more limited basis).

Importantly, the tax rate under the test is set using income tax rates, meaning that some sellers will face a tax rate of as high as 39%. In contrast, the dumped capital gains tax (CGT) proposal was for a much lower 15% rate.

The bright-line test will, in some regards, change incentives over where investment income is directed, with a more equal treatment of different forms of income. But it’s important to note too that the change will slow sales volumes in the years ahead, as properties are held onto longer to avoid the tax.

The extension to 10 years exempts new builds (they are still subject to the 5-year bright-line test), with a focus on incentivising investors to increase housing supply. We expect that this exemption will help to redirect capital into additional construction.

Removal of interest deductibility

The removal of interest deductibility made the most waves from the housing package announcement. The change means interest payments will not be able to be deducted from rental incomes to limit tax obligations. Far from being a loophole as the government contends, interest deductibility is a usual cost of doing business usually afforded to all businesses (but now not in property).

The change fundamentally alters the financial mathematics of property investing. BusinessDesk analysis shows that investor property yields turn negative for highly leveraged investors when interest rates head above 3%. Infometrics expects the changes will see highly leveraged investors sell out of the market, either to lower-leveraged investors or to first home buyers.

Low interest rates at present and the four-year phase in period should limit any immediate need from the bulk of investors to sell. But we also recognise the possibility of a knee-jerk reaction to the news which could see sales elevated for a period.

Given the strong level of housing interest still, combined with a still-existing housing undersupply, still positive housing returns, and a lack of viable alternative investments (at the same scale), we don’t expect to see a complete sell-off of investment properties.

It’s important to recognise the immediate reaction to the announcement, with current investors threatening to, variously, send rents skyrocketing, sell houses en masse, or illegally boot our tenants on the coldest day of the year.

Previous changes, including recent Healthy Homes standards, saw similar expectations for massive investment property sell-offs and leaving properties vacant. Yet investment lending in December 2020 was sitting around 90% higher than a year earlier. With investment returns still positive for many, the changes will prompt a hard look at spreadsheets, but not a wholesale collapse in investment activity.

House prices to slow, not drop, and rents will continue rising

Infometrics currently expects that the housing package changes will contribute to house price growth slowing back to double digits by the end of 2021. The combination of stricter Reserve Bank loan to value ratio (LVR) restrictions, reduced investor activity due to the housing package measures, and potential upcoming limits on interest-only lending, will take the wind out of the market’s sails.

However, we see there to be a less likely chance of house prices falling, given the housing undersupply remains and low interest rates will support housing attention and activity.

Concerns have been raised over if the changes might see landlords raise rents substantially to recover costs. We see some scope for rents to push higher as some landlords who are able to recover costs. But overall increases in rent are more likely driven by factors that already were pushing rents higher – a shortage of rental stock. With supply and demand for housing imbalanced, rent increases have been limited by tenants’ ability to pay, which has seen rental inflation at a much lower rate than house price inflation. Without tenants suddenly earning more money, there is a limit on how much extra rent could be charged.

Over time, as supply issues are addressed via increased land availability, changes such as the removal of interest deductibility will see rents rise to higher than they otherwise would have been, as when supply and demand are more balanced, landlords will be looking to recover costs. For investment returns to be positive into the future, either house purchase prices must be lower, or rental income must be higher.

Supply still needs to be addressed, but it’s not quick

By themselves, the housing package policies will not fix the housing crisis. A steady pipeline of housing supply, enabled by increased funding for infrastructure and regulations that free up land for new builds and intensification, remain at the crux of fixing the housing crisis. Adding more houses, after such a long time of turning a blind eye to the need for more housing, is not simple, and definitely not fast.

There is little that can be done in the short term to magically increase housing supply. Construction levels are limited by a range of factors, including staffing levels, construction material availability, and regulatory timeframes. Even zoning considerable amounts of land still requires work to connect services, then build new dwellings – using resources we simply don’t have more of in the short term. Prefabrication of housing could speed up the process but hasn’t yet successfully penetrated the main construction market at scale.

Housing package a start, but can’t be the end

It will be a slow grind to address New Zealand’s housing crisis, but parts of the housing package announcement recently have started to get things moving. More work is needed to unlock land supply, ensure adequate infrastructure is available, and that New Zealand has a workforce to build more dwellings. Equally, a focus is needed on delivering the outcomes already promised, with execution still to be seen after a range of substantial announcements.

The spotlights have been turned on the housing market once more. Now the real work begins to keep the batteries running while builders go to work.

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