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Last Article Uploaded: Wednesday, October 27th, 6:26PM


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Scrapping tax deductibility not the way to go

Limiting tax deductibility for property investors’ mortgage interest would be a better game changer than scrapping it altogether, says Westpac acting chief economist Michael Gordon.

Tuesday, March 23rd 2021, 6:06PM

“It would achieve the same purpose with a less disruptive impact,” Gordon says.

The Government’s complete removal of interest deductibility came as a surprise to economists when new housing rules were outlined to skew the housing market from investors to first home buyers. 

Gordon says it was never going to be easy for the Government to thread the needle between housing affordability and encouraging new housing supply without disrupting the economy’s recovery from the Covid-19 shock.

However, he says the tax deductibility change veers too far in one direction.

“Removing interest deductibility goes well beyond what’s needed to tilt the playing field in favour of owner-occupiers, and makes much of the investor market unviable under current conditions.

“A less disruptive approach would have been to allow partial deductibility, such as a thin capitalisation rule,” Gordon says.

There is already precedent for these rules in some sectors. The aim is to restrict leverage that serves no commercial purpose other than to reduce the tax bill.

“A similar approach would be appropriate for addressing the imbalances in the housing market. It would be a question of calibration, but it would be possible to tip the balance in favour of owner-occupiers without excessively disrupting the rental property market.”

Under the Government’s latest changes, rental property owners will no longer be able to deduct mortgage interest from their expenses.

This change will take effect from October 1 for properties bought after March 27. For properties bought before that date, deductibility will be phased out over the next four years.

Other measures just tinkering

Gordon says the other changes, such as lengthening the bright-line test, are largely tinkering around the edges. Removing interest deductibility will probably make any other measures to control demand redundant.

Westpac has for some time highlighted the dominant role financial factors, such as tax rates, play in determining house prices. “The removal of interest deductibility cuts to the heart of the issue, in a way that so many of the popular proposed solutions don’t,” says Gordon.

However, he says there will be consequences for the economy.

“As the housing market reorients, there could be a sharp fall in house prices, which will weigh on households’ willingness to spend and it will also discourage new home construction.

“That will put the economy further below its potential, making a sustained return to the Reserve Bank’s inflation target more difficult.”

Interest rates

He says interest rate hikes remain a distant prospect. And indeed more monetary easing might be needed to support the economy through the transition phase.

“A negative OCR is still on the cards.”

The Government is looking at an exemption for newly-built homes, with the aim of encouraging investment in the housing supply while still dampening demand.

Gordon believes the impact on homebuilding will be negative.

“New houses will be more attractive relative to existing ones, but not in an absolute sense.

“The issue is that buyers will have to consider the resale value, and any future buyer will be subject to the no-deductibility rule. Falling house sale prices will discourage development.”

Removing interest deductibility tilts the balance dramatically in favour of owner-occupiers, who will now be the ones who determine the market price of houses.

A rough calculation by Westpac suggests owner-occupiers average willingness to pay is about 10% below current prices, which suggests prices could fall by that much in the long term. That in itself is not particularly onerous – it would bring prices back to where they were four months ago.

Gordon says there could, however, be a much greater decline in the short term, while the housing market realigns itself.

“Without interest deductibility, property investors will need to see a higher rate of return to justify their investments.

“That could mean higher rents, although that will be constrained by tenants’ ability to pay.

“The more likely way is that highly-leveraged investors will sell out – at a reduced price – to owner-occupiers or less-leveraged investors.”

There were similar scenarios in the UK, which started phasing out interest deductibility in 2017. House price growth slowed to zero, rents rose to some degree, and housing construction slowed. More recently, the resulting shortage of housing had started to lift prices again.

Other changes

Gordon believes the change to interest deductibility will be effective enough to make other demand-dampening measures redundant.

The Reserve Bank may add debt-to-income ratio (DTI) limits to its macroprudential toolkit, but it’s unlikely that they will need to be activated, as highly-leveraged investors will already have been stopped in their tracks.

“If anything, the RBNZ’s next step may be to remove loan-to-value (LVR) restrictions again, as there will no longer be a need to restrain the growth in mortgage lending.”

Tags: Bright-line test house prices housing market investor lending property investment tax Westpac

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AIA 4.55 ▲3.25 ▲3.75 ▲3.99
ANZ 4.59 ▲3.84 ▲4.30 ▲4.54
ANZ Blueprint to Build 1.68 - - -
ANZ Special - ▲3.24 ▲3.70 ▲3.94
ASB Back My Build 2.04 - - -
ASB Bank 4.45 ▲3.25 ▲3.75 ▲3.99
Basecorp Finance 5.49 - - -
Bluestone ▲3.74 ▲3.54 ▲3.89 ▲4.09
BNZ - Classic - ▲3.24 ▲3.79 ▲3.99
BNZ - Mortgage One 5.15 - - -
BNZ - Rapid Repay 4.60 - - -
Lender Flt 1yr 2yr 3yr
BNZ - Std, FlyBuys 4.70 ▲3.84 ▲4.39 ▲4.59
BNZ - TotalMoney 4.70 - - -
CFML Loans 5.15 - - -
China Construction Bank 4.49 4.70 4.80 4.95
China Construction Bank Special - 2.65 2.65 2.80
Credit Union Auckland 5.95 - - -
Credit Union Baywide 5.65 3.95 ▲4.10 -
Credit Union South 5.65 3.95 ▲4.10 -
First Credit Union Special 5.85 2.95 3.45 -
Heartland Bank - Online 2.25 1.85 2.35 2.65
Heretaunga Building Society 4.99 3.80 3.90 -
Lender Flt 1yr 2yr 3yr
HSBC Premier 4.49 2.19 2.45 2.69
HSBC Premier LVR > 80% - - - -
HSBC Special - 2.25 - -
ICBC ▲4.15 ▲2.89 ▲3.29 ▲3.49
Kainga Ora 4.43 2.88 3.28 3.59
Kainga Ora - First Home Buyer Special - 2.25 - -
Kiwibank 4.00 ▲4.14 ▲4.44 ▲4.84
Kiwibank - Offset 4.00 - - -
Kiwibank Special 3.75 ▲3.29 ▲3.59 ▲3.99
Liberty 5.69 - - -
Nelson Building Society 4.95 2.99 3.24 -
Lender Flt 1yr 2yr 3yr
Pepper Essential 4.79 - - -
Resimac 3.39 2.98 2.79 3.29
SBS Bank 4.54 3.05 3.45 3.75
SBS Bank Special - 2.55 2.95 3.25
Select Home Loans 3.49 3.34 2.99 3.34
The Co-operative Bank - First Home Special - ▲2.79 - -
The Co-operative Bank - Owner Occ 4.55 ▲2.99 ▲3.60 ▲3.89
The Co-operative Bank - Standard 4.55 ▼3.49 ▲4.10 ▲4.39
TSB Bank 5.34 ▲3.75 ▲4.20 ▲4.44
TSB Special 4.54 ▲2.94 ▲3.40 ▲3.64
Wairarapa Building Society 4.99 3.55 3.49 -
Lender Flt 1yr 2yr 3yr
Westpac 4.84 ▲3.79 ▲4.39 ▲4.59
Westpac - Offset 4.84 - - -
Westpac Special - ▲3.19 ▲3.79 ▲3.99
Median 4.57 3.24 3.70 3.99

Last updated: 27 October 2021 8:49am

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