Investors key to driving up house prices

Landlords must be feeling pretty unloved these days.

The Reserve Bank last week signalled that tighter restrictions on property investors' access to credit are on the way before the end of the year.

The Labour Party's housing policy package, released last Sunday, includes an extension of the "bright line test", for when capital gains are taxable, from two years to five -- and a willingness to think about negative gearing.

And the Prime Minister's comment that the Reserve Bank should just get on with tightening the macro-prudential screws was hardly music to the Property Investors Federation's ears either.


So why are property investors in policymakers' sights? Why pick on them?

In brief, it is because in the housing market they tend to be the marginal buyers who set the price. The higher the price it is rational and possible for an investor to pay, the more house price inflation there will be, and the faster the bubble will inflate.

Debate about the housing crisis suffers from a tendency to muddle up two layers to the problem. They are connected, but they are not the same.

The more important is the fundamental, physical imbalance between the supply of and demand for housing. It is driven by growth in the population on the one hand and growth in the housing stock on the other.

Clearly, at that level supply has not kept pace with demand and while that situation persists -- and it will for years yet -- there will be upward pressure on prices.

But then there is the second level to the issue, which determines how much prices rise during these conditions of housing shortage.

At this level, supply is properties for sale and demand is what buyers are willing and able to pay.

In that context, the things that matter on the demand side are incomes (current and expected) and policy settings about the cost and availability of credit, the tax incentives for New Zealand investors and the openness to investment by non-residents.


Those are the things that drive how much prices rise. They determine how much some New Zealanders can profit and others must suffer in conditions of excess physical demand.

The Reserve Bank is doing what it can.The Government is not.

So it is a cop-out for the Government to endlessly repeat its mantra that it is all a supply problem and to blame local governments' restrictive town planning rules for a sluggish supply response.

Of course physical supply is crucial, but that does not excuse inaction on the taxation front.

The Government was quick to point to Massey University's home affordability index, which records an improvement in affordability over the past year -- the past quarter, not so much -- driven by lower mortgage interest rates.

But as Reserve Bank deputy governor Grant Spencer reminded us last week, relative to incomes New Zealand house prices are a third higher than their long-run average and the second highest in the OECD.

And though one- and two-year mortgage rates are in the low 4 per cent range, the lowest since the 1950s, it is folly to expect them to stay there indefinitely.

At the moment the Reserve Bank is in a bind. It cannot raise interest rates to lean against a housing bubble. Global rates are so low that if it did, the impact on the exchange rate is the last thing it needs when consumer price inflation is so weak.

"Conversely further reductions in the [official cash rate] could pose a risk to financial stability through their effect on credit growth and house prices," Spencer said.

Quotable Value reports that nationwide house prices are rising at their fastest rate since 2004 -- 13.5 per cent over the past year. In Hamilton it was 29 per cent.

Conversely further reductions in the [official cash rate] could pose a risk to financial stability through their effect on credit growth and house prices.

In Auckland investors now account for 46 per cent of all sales, QV says, up from 37 per cent in 2012.

The combination of high investor demand and rampant house price inflation is no coincidence. It reflects the toxic interaction between how the tax system and the banking system view the purchase of rental properties.

For the taxman, the landlord is in business and entitled to deduct all the costs, including interest, incurred in earning taxable rental income.

For a bank, the landlord is someone borrowing against the security of a dwelling and banks are generally happy to lend as much as the Reserve Bank allows.

But few other businesses can gear up their balance sheet to the same extent. Few other investors can enjoy the same benefits of leverage in a rising market, amplifying the increase in their equity until they are ready to collect their tax-free capital gain.

The message from the tax system is clear: if you want to provide for your old age, don't save money. Instead, borrow and engage in highly geared plays in the housing market.

Dealing with this now perilous distortion requires a pincer movement, attacking it from both the tax and banking (macro-prudential) sides.

Otherwise gravity will prevail, in the form of the ever-widening disconnect between house prices and household debt on the one hand and incomes on the other.

The Reserve Bank is doing what it can. The Government is not.

The Property Investors' Federation naturally does not see it like that.

Making rental property less attractive to investors can only have a negative effect on the supply of rental property, says its executive officer Andrew King, and if Labour's de facto capital gains tax were introduced rents would have to increase.

It is a specious argument. Measures which reduce the amount it is rational for an investor to pay for an existing property do not affect the size of the housing stock. If it means one more owner-occupier and one less tenant, the net effect does not reduce the supply of rental property.

And are we expected to believe that when setting rents, landlords do not already charge all that the market can bear?