Andrew Bruce says the tax advantages of property investment may be more fiction than fact

By Andrew Bruce*​​​

It seems you can’t go anywhere these days without somebody talking about, or giving their opinion on, the Auckland property market.

Within the last few weeks we’ve had the usual barrage of commentators once again misleading the public by saying that property investment is tax advantaged, and even the Reserve Bank have now joined in on the discussion.

As usual, the solutions proposed never really target the heart of the matter but promote the introduction of a myriad of taxes or marco-prudential tools ranging from:

1. Enforcing the banks to hold higher capital requirements on residential property investment, which would probably lead to higher borrowing costs

2. A Capital Gains tax

3. A Land Tax

4. A tax on Deemed rate of Return, 

and the list seems to grow by the day.

Firstly let’s look at the major misconception that is frequently propagated, that property is tax advantaged.

Back in 2007 the then Deputy Commissioner of Inland Revenue Department, Robin Oliver, was asked by a Government Select Committee if there were tax advantages for rental housing. 

Mr Oliver’s response was ‘...the short answer is there is none.

Rules about expenses for deducting costs such as interest upkeep and maintenance, as well as paying tax on income were the same for investment in shares or anything else.

In fact under housing case, the capital gains boundary is brought back a bit’. 

Since this statement was made, depreciation on residential buildings as a deductible expense and Loss Attributing Qualifying companies have been deleted and a tainting rule extended that is exceptionally wide reaching.

In October 2009 a new associated persons (“tainting”)  rule was brought in which made separating  a trading/developing entity and investment entities very difficult. The new associated persons tests are very comprehensive and previously situations where the sale of a property investment property that may have been on capital account (“tax exempt”) can possibly now be subject to tax if of sold within 10 years and where parties can be deemed to be associated to a separate trading or developing entity at the time of purchase.

When you consider the impartial commentary of Mr Oliver and then take into account what has happened subsequently, an argument can certainly be made that property investment now is actually tax disadvantaged rather than tax advantaged, as purported by many.

As anyone who follows property will be aware, the property market is cyclical.

During the years 2008 through to 2011 the market was exceptionally flat and during much of that period it actually went backwards.

In my opinion one of the reasons the property market didn’t collapse like many of the financial markets did during this time is we went into The Global Financial Crisis (GFC) with a shortage of houses in Auckland as opposed to an oversupply.

Then, during the period of the GFC, this undersupply was exacerbated as there were very few developers building and the supply of housing in Auckland became even more constrained.

Move forward seven years from the start of the GFC and the New Zealand economy is the envy of many other countries, and as a result we are seeing many migrants moving to New Zealand and these people need accommodation.

Record low interest rates along with a shortage of houses in Auckland is a recipe that is always going to produce price pressure in the market.

With the above in mind, my question is what would be the situation today rather than having a shortage of 20,000 houses in Auckland if we had an oversupply of 20,000 houses?

One thing I learnt from my Economics lecturer many years ago was that if you have an imbalance between supply and demand then there will be a price reaction.

Looking simplistically at the equation why do we have such an under supply of houses in Auckland?

You could argue there was limited building during the GFC, which would be correct, however we went into 2008 with a shortage of houses. 

I find it hard to believe we have a shortage of developers who are willing to build.

However, before a developer is willing to risk their capital and that of their funding partners they need to ensure there is sufficient profit margin for the project to be worthwhile. 

Now we can pick on things like the cost of building, resource or subdivision consents but there does need to be a degree of checks and balances to ensure the buildings that are built are safe and intensification occurs in a planned and structured way.

It is the costs incurred behind the scenes of this process that I believe can become a significant barrier.

These range from:

1. Development contributions

2. Water meter levies

3. Extra costs associated with onerous conditions of consent

4. Time delays and uncertainty

While I fully accept the cost of development and infrastructure have to be paid for from somewhere, rather than loading these costs purely onto each new development maybe it’s time a debate was started as to whether these costs should be distributed across the entire rating base, this is particularly for items 1 and 2 above.

In saying that, most developers have a degree of certainty about the costs of 1 and 2 and can then factor them into their feasibility studies.

If these figures don’t work, they don’t build.

It’s pretty simple. The real drain on budget can emanate from points 3 and 4.

The reason I believe these are such big hurdles for developers is because many are 

highly leveraged when undertaking these type of projects. When you add in extensive unbudgeted costs arising from 

onerous conditions of consent or excessive time delays this causes significant follow on effects with holdings costs.

Each days delay costs money. Big money.

If you don’t believe me ask any developer about the impact of holding costs and delays. 

So, if we are serious about increasing Auckland’s supply of housing I believe we need to look for long term sustainable solutions to facilitate development rather than placing hurdles in the way of developers or bringing in more regulation and taxes. 

As I outlined earlier in the article, we would be in a very different position if today there was a 20,000 oversupply of houses in Auckland as opposed to a 20,000 undersupply.

So the question has to be asked why is this the case and what can we do to solve it?

------------------ 

*Andrew Bruce is president of the Auckland Property Investors' Association.

---------------------------------------------------------------------------------------------------------------------------------------

Our free Property email newsletter brings you all the stories about residential and commercial property and the forces that move these huge markets. Sign up here.

To subscribe to our Property newsletter, enter your email address here. It's free.

Email:  

----------------------------------------------------------------------------------------------------------------------------------------

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment or click on the "Register" link below a comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current Comment policy is here.

4 Comments

It is very obvious that PI is taxed just the same as any other business and has no advantage (or as you say is disadvantaged) taxwise relative to other businesses.

When this is pointed out the usual response is that the issue is not comparing it to other business types, but comparing it it to owner occupiers. How one could possibly work out whether there is a tax advantage or not in such a situation is beyond me. A business buying a car presumably has a tax advantage at face value over me buying a car - but does it really?

In my suburbs (which are having the greatest price gains) all the renters are being sold and purchased by owner occupiers so I can't see how the supposed 'tax advantage' is playing out?

As Fonterra are finding out with their milk auction system. Changing from an in-demand situation to one of over-supply on an open (no value add) market has catastrophic effects on buyer-market vs seller-market. (phrases I haven't heard for a long time).

Increase the supply and prices will fall. Exactly the thing a developer doesn't want. Isn't that what happened to Alan Bond? he had a nice little system of pre-sell, finance through third-party speculators, make margin in the build and in the sale... until over-supply happened since the new high end buyers could no longer afford to finance their purchasers in the GFC, leaving his operation with an over-supply situation, debts, and a bunch of retail investors who thought property could never fail (and looking for someone to blame).

Developers have no interest in creating oversupply. they leave that to silly people like Fonterra (prices are low? produce more volume to make up the turnover $). It's in developers interest not to over produce, and the best way to do that is not get caught with the materials or land.

the other thing that has changed - in the wayback machine, the councils used to responsible for the infrastructure including cost. So competition to develop a section was a low-entry challenge.

With all the rules, the finance, and the extra infrastructure; there's now a very high challenge level for new entrants. Can't just hire a builder and some hammerhands, or a plumber and get a few mates with spades. That means the price factor for a new build is no longer $15,000 and plenty of beer, but a fortune in consultants, support staff, and start with $500,000.

You get a _lot_ more supply at 15,000 than at 500,000; marketing price rules apply, lower the cost, increase the appearance/market size.

Do property investors really have "tax benefits?"

Monday 30 November 2009
http://www.landlords.co.nz/article/3608/do-property-investors-really-hav...

Any tax advantage is not really the question.
The real advantage is the ability to gear the invested capital with some assurance that there is a guaranteed income stream subject to vacancy, and the support of banks which are prepared to lend at attractive rates compared to other business activities.

Take away deduction of interest cost as an allowance from the tax liability and the result is that any landlord who owns the property outright is in the same position as now. In fact both the prospective buyer occupier and the full ownership landlord will be better off because they will get the property cheaper than now.

Argue that one away if you dare.