Interest rates have historically been the RBNZ's main tool. However, a weakening economy and low inflation are seeing many pundits call for multiple rate cuts. Far from being a tool to lean against the bubble, rate cuts may throw more fuel on the fire.
Interest rates
Rather than the price of money, the RBNZ has attempted to constrain the quantity available by restricting high loan-to-value mortgages. Further, the RBNZ has implemented stronger capital requirements on banks. Should the bubble implode, then more capital will be in place than previously to meet loan losses but there has been little obvious impact in curbing prices.
A key problem with globally low interest rates is they have been built into house prices as though they will last forever.
A key problem with globally low interest rates is they have been built into house prices as though they will last forever. Rather than having a lower mortgage repayment, buyers are paying more for the house. At 5.8 per cent, a 20 year mortgage for $500,000 has an average monthly repayment of $3,525. Assuming a 20 per cent deposit, this allows $625,000 to be paid for a house. If the rate went up to 7.8 per cent, the repayment of $3,525 would only support a $428,000 mortgage, meaning $535,000 could be paid for the house - 14.4 per cent less.
Interest rates are very low because inflation is very low. A generation ago, homebuyers faced mind-bending mortgage rates of 15-20 per cent but wage inflation ran at similar levels. In a high inflation environment, fixed debts are quickly inflated away and become trivial in real terms after a few years. No such luck for today's borrowers. The benefit of the low rate has been paid away up-front into the high house price but the $500,000 mortgage will still be a large amount of money in a few years' time rather than having been inflated away.
Rents
Another way of thinking about the "money illusion" of low rates is that rents have lagged well behind prices, resulting in a collapse in rental yields. It is only rational to buy a rental property on a very low yield if you expect strong price growth. The belief seems to be that house prices will go up in the future because they always have in the past. Hundreds of billions of dollars were lost in the USA after 2008 on this most dangerous of premises.
One promising channel for policy action is that if investors can be convinced by credible commitments to deflate the bubble, then their expectations of price growth may recede and their demand to buy houses with it.
One promising channel for policy action is that if investors can be convinced by credible commitments to deflate the bubble, then their expectations of price growth may recede and their demand to buy houses with it.
The well-respected Buckle Report (2010) concluded that, "there is a major hole in the tax system concerning the taxation of capital, which is manifest in high investment and low returns in the property market." That was five years ago! The study also outlined a marked decline in landlords' net rental income since 1999 and that this figure turned negative from 2007 onwards - in other words, the sum of all rental housing owned in NZ delivers a loss. This shows just how entrenched the expectation is of ever-repeating capital gains.
Capital gains
Aside from removing the tax deductibility of a structure's depreciation, no major changes were implemented. Theoretically, a capital gains tax appealed but many assets have no market price and cash-flow difficulties would be caused for others. A land tax was considered but it would do nothing to address investors' tax advantage and would generate cash-flow issues. Recent rates increases by the Auckland Council are providing an unfortunate real world experiment of a land tax but seem to be having little impact....yet.
Capital gains taxes would be a huge employment generator in Wellington given the need to define and police just what constitutes a dwelling and they would require the return of death duties and gift taxes to stop avoidance. Further, unless it was made retrospective, it is hard to think of anything more foolish than setting the cost basis at the top of a housing bubble - when the bubble eventually ends, the IRD would be paying refunds for many years to come! The Budget's reaffirmation of the existing capital gains tax based on "purchasing for the purpose of resale" and a two year holding test seem sensible.
One way to lower investors' expected returns would be to remove the tax advantage they have versus owner-occupiers.
One way to lower investors' expected returns would be to remove the tax advantage they have versus owner-occupiers. How does a first home buyer stand a chance at auction when an investor can tax-deduct interest payments, rates and maintenance? Limiting deductibility for residential investors would be complex and could have spill-overs for bona fide commercial property but may be worth investigating.
Stamp duty
A simpler way to deal with investors' privileged tax position would be to re-introduce stamp duty on any house that is not purchased by an owner-occupier. The duty could be controlled by the RBNZ so that the rate does not move with the election cycle. It might even be made region specific. Whether levied on the buyer or seller or both, it would lower investors' expected return and should therefore lower the price they are willing to pay for a house.
A stamp duty also has the happy side-effect of raising income which could be used to build infrastructure to support new supply. Australian State Governments are raking in stamp duty proceeds at present and this is giving them a far greater capability to invest for growth than is the case in Auckland.
Special Housing Areas
The Government's current focus appears to be aimed at lifting supply with Special Housing Areas. To date, this has not affected prices or expectations. In physical terms, even if new houses are delivered, it may not matter much. The number of houses built in any one year is tiny relative to the outstanding housing stock. Households only need spread out or squeeze up a little and the impact of a change in house construction is totally offset. Strong immigration exacerbates this.
If the bubble is to be fixed by supply alone, then a full throttle commitment is needed to build Auckland up and out for many years to come.
If the bubble is to be fixed by supply alone, then a full throttle commitment is needed to build Auckland up and out for many years to come. In the short term, this will dampen investors' price expectations, and in the longer term, the physical additions will eventually add up to a meaningful percentage of the housing stock. The current approach appears to be characterised by caution and nimbyism and is falling short of the all-in commitment that is required.
One problem cited by the Auckland Council for the slow release of land has been the cost of infrastructure such as roads, water and sewerage to new sub-divisions. In cash terms, this cost far outweighs the year one returns from the lift in the rating base. However, we live in a world where interest rates are very low and investors are desperate for dependable long-term returns. Surely very long-term infrastructure bonds could be issued, with the interest paid by the expanded rating base.
Offshore investors
How about offshore investors? The Budget contained new information requirements for offshore buyers which will impact to the extent that buying is using ill-gotten gains. It is impossible to know the size of this sub-group. Australia has far better information than NZ and using official data, recent Credit Suisse research estimated that Chinese buyers accounted for 23 per cent of new supply in the Sydney housing market in the most recent year. Add other countries and it is not inconceivable that one third of new supply could be going to offshore buyers.
Anecdotal feedback cited by Credit Suisse from juwai.com points to Auckland having at least as much appeal as Sydney adjusted for market size. The difference in Australia is the extremely aggressive policy stance forcing offshore purchasers to buy new houses rather than existing ones.
Immigration policy is a whole separate issue with its housing linkages being only one aspect. However, it may be worth emulating Australia and forcing offshore investment to be solely in new supply.
Realistic options
In conclusion, there are a number of realistic policy options:
• Interest rates are not an option at present, so the RBNZ has sensibly imposed modest lending restrictions and required higher levels of bank capital.
• Stamp duty, possibly on investors rather than all dwellings, would tick many boxes.
• For new supply to work, a full throttle commitment must be made to building Auckland up and out rather than the current half-hearted effort.
• Infrastructure bonds might be considered.
• The impact of offshore "investment" needs consideration, with Australia's policy of forcing offshore purchasers to buy new developments worth examining.
Matthew Goodson is managing director at Salt Funds Management, which has a $270 million listed property fund among $1.5 billion of funds under management.
