The Government could get an extra $500 million to $1 billion a year in tax revenue, after changing the rules on interest deductibility for property investors, an economist estimates.
In a research note this week, ASB senior economist Mark Smith estimated the potential tax gain after Tuesday's announcement that - in a change to be phased in from October - landlords will no longer be able to claim tax deductions for mortgage interest payments on rental properties.
"It will generate a significant amount of additional tax to be paid by property investors, that is likely to be in the region of $500m to $1b per annum according to our estimates," he said.
Inland Revenue has been unable to provide information on how much extra tax the changes would generate.
New Zealand has 600,000 rental properties worth $400b to $500b, said Smith. About 25,000 properties are sold annually to investors and the interest deductibility had been important for higher geared buyers, he said.
Revenue Minister David Parker said the current tax system favoured debt-driven residential property investment over more fully taxed and more productive investments.
To reduce investor demand, the Government would remove the "advantage" investors have over first home buyers, he said.
"Cabinet has agreed to remove the ability for property investors to offset their interest expenses against their rental income when they are calculating their tax," Parker said.
Ministers were also considering changing the rules on interest-only loans to speculators. The Reserve Bank will report back on this in May and any proposals around debt-to-income ratios for lending, particularly for investors, he said.
Smith said: "The $82b nationwide mortgage debt associated with rental properties will no longer be generating a significant interest expense for property investors to use to offset rental income. It will generate a significant amount of additional tax to be paid by property investors."
House prices would need to fall by 30 per cent, or rents would have to rise 30 per cent, for a new property investor to be in the same financial position that they would have been in before the Government deductibility change, Smith calculated.
"Of the announcements, the end of the ability to deduct interest rate expenses is arguably the most significant. It will change the after-tax position of the typically geared property investor, with the impacts most acute for new investors, who are typically more highly geared with stretched cashflow positions.
"For a fresh investment purchase of a typical investment property at 40 per cent deposit, to achieve the status quo after-tax position implies paying 30 per cent or so less for the
property, charging nearly 30 per cent more rent or stumping up with a 60 per cent deposit," Smith said.
In the real world, a more likely outcome would be a more moderate rent increase and a willingness to pay slightly less now for the house – meaning the market price would then be more influenced by owner-occupiers' readiness to pay.
For less highly geared investors with healthy cashflow, the impacts would be more modest, Smith noted.
The heat was likely to come out of house price growth much more quickly now.
Westpac economist Michael Gordon said after Tuesday's announcement: "We estimate that house prices could settle around 10 per cent lower over the long term. However, there could be much greater effects in the short term as some investors exit the market."
Lower house prices would have knock-on effects for general economic activity, spending and inflation, Gordon said.
Landlords have decried the changes.
Andrew King, NZ Property Investors Federation president, and Sharon Cullwick, federation executive officer, were both taken aback by the Government decision to eliminate interest tax deductions.
"What, so every other business in New Zealand can still claim tax deductions, but not landlords?" King asked. "You're joking! This is just bizarre, it's crazy."
The sums involved could be tens of millions of dollars, King said, and that would now be lost to landlords, already struggling under Residential Tenancies Act changes from last month which swung the power in tenants' favour.
King said: "We all know one of the major downsides for investors in property is that the rent doesn't cover the costs of running many places. In New Zealand, it's cheaper to rent than to buy a house.
"This change will make it almost impossible for people to provide new rental accommodation. This means the only people able to buy rental properties in the future will be those with almost all the cash to pay for the property."
Asked why this would be such a big problem when mortgage interest rates are at all-time lows, King said: "Paying the interest on mortgages for landlords is a huge issue."