Property changes, the unintended consequence, and what it means for you
Unless you’ve been living under a rock, you’ll know that property prices have gone through the roof. Today, the Government announced their response. We’ve put this together to share some of our initial thoughts, and what it means in practice.
Now, apologies if you’re politically inclined one way or the other. We’ve tried to strip our views out of this. Suffice to say, this is a fundamental change from a Government who has previously just tinkered around the edges when it comes to tax.
In short, here’s the overview of the changes:
- Brightline Test: This gets extended from 5 to 10 years (as well as applying in more situations, like when you move in and out of a family home ). Fundamentally, this is a capital gains tax on residential rental properties.
This applies to property acquired on/after 27 March. The existing rules apply to property acquired before this date. In this context, acquired (broadly) means 'has an unconditional contract to purchase'. This means If you’re wanting to beat the rules, you have a four-day window to get a previously signed conditional agreement to an unconditional status.
- Interest Deductions: When you borrow to buy a rental property, you can no longer offset the interest against the rental income.
These rules apply from properties acquired on/after 27 March.
For properties you already own, the rule will be introduced in 25% increments each year from the 2022 financial year.
- Support for First Home Buyers: The existing grants and loans made available apply to more people in more situations.
What interest deductibility means:
Take a regular rental property, worth $700,000, being rented out for $700 per week.
If you’ve bought it for cash, then today you’ve got a tax bill of around $8,700 per year.
If you’ve bought it with a mortgage, paying 3% interest, then your tax bill is around $1,800.
The changes today mean you can no longer claim the interest payments against the income you earn. Your tax bill in both scenarios would now be the same (i.e. mortgage or not, your tax bill from the rental is $8,700).
The implications for investors
If you own a rental today, with no lending on it, then today’s changes won’t make any difference at all.
If you own a rental with a mortgage, there will be a $8,700 tax bill coming. It’s not coming immediately – it will arrive in 25% increments over the coming four years. We’re recommending you don’t make a decision on your next step in the short term. Lets wait, see what property prices do, and then make a decision on your ownership.
So, this change will have a significant impact on smaller scale investors with one or two properties. Likewise, it will have an impact on anyone just starting out in investing. Largely these are ‘Mum and Dad’ investors who are trying to build a retirement nest egg.
It won’t on the other hand impact established investors with significant equity in their rental properties. For them there’s no/little change.
The impact on Renters
We can only see these changes increasing rents in main centres. There will be a group of Mum and Dad investors who sell their rental properties. Statistics show that these properties are typically sold to First Home Buyers, then reducing the supply of rental properties.
Sixth Form economics says when supply of something drops, the price goes up. So, if the supply of rental properties falls away then rents go up.
The impact on property prices
We can’t see these tax changes impacting the price of property in the medium term. Yes, there will likely be a short-term blip as people overreact. But when people work out how the land lies then we’ll be back to normal.
Normal might be flat house prices (which is good). We just can’t see these changes dropping prices and making houses more affordable for First Home Buyers.
Loss ringfencing didn’t stop price increases. Brightline didn’t stop price increases. Nor did LVR restrictions, nor did capital gains tax in Australia. We just can’t see things changing as a result of the tax changes (which only impact investors who have significant mortgages).
The impact on first home buyers
On the other hand, the support for First Home Buyers through the Welcome Home Loan and the First Home Buyer Grant will help. These changes should have gone further (for example they only support the purchase of houses in Wellington up to $650,000).
This threshold is frankly too low (unless you want to buy an apartment in Wellington). They also should have offered support in different areas – for example by guaranteeing deposits for First Home Buyers.
The impact on particular properties
There are different rules for specific types of properties. For example, new builds are treated differently under these rules. We would expect demand for new builds to increase.
These rules don’t apply to commercial or industrial property. Again, we would expect this to increase the demand for these properties.
We also expect this to drive more people towards the share market. Like property, the share market has also increased significantly post Covid. Shifting from property to shares comes with a different set of risks – that’s not to say don’t do it, simply that there’s different things to consider.
Finally, there’s property developers. They aren’t impacted at all by these changes. We expect to see more people doing property developments off the back of the announcements.
What else could they have done
It’s easy for us to sit here and throw rocks at what the Government has done (thankfully we’re not running the country).
TL;DR: They’ve missed some easy wins.
That said, there’s two things they could have done.
Firstly, the “problem” is that property prices for First Home Buyers are out of reach. They would have supported them more by increasing the thresholds for when they can get Government support (the $650,000 in Wellington mentioned earlier). They also could have supported them through direct guarantees and assistance (like they did for business lending post Covid).
Then, it’s how they target landlords. Targeting all landlords as “speculators” as part of a “war on property speculation” goes too far. Removing interest deductibility will have a significant unintended consequence of reduced rental supply, and reduced outcomes for people’s retirement. Instead, they could have looked at applying the rules for significant investors (with say three properties) who could be treated differently to those with (say) one property.
Alternatively, income-debt ratios for targeted groups would have helped more than what’s landed today.
What to do now
Here’s what we’d recommend you do now:
- Do nothing. See what property prices do, then make a decision on your property investments once the dust settles a little.
- If your view on residential rentals changes, look at investments not impacted by the new rules – for example industrial property or businesses. The rules for them are now materially advantageous.
- Reach out if you’d like join one of our upcoming Property Structuring workshops where we’ll be covering what we see as best practice structuring moving forward.
As always, if you have any specific questions please reach out.
Did you find this article useful?