By Bernard Hickey
Treasury was so concerned about Auckland's house price explosion in the lead up to the May 21 Budget that it looked at other options for slowing demand from rental property investors in the region.
The options studied but not adopted included a 1% per year tax on the capital value of rental properties, a mortgage interest levy and removing the ability for landlords to claim half their interest costs for tax purposes.
Treasury papers for Budget 2015 showed it advised that such measures could be the shock that reset unrealistic investor expectations and led to significant price falls in Auckland.
It also worried that the cumulative effect of imposing such a levy or removing the ability to claim interest costs for tax purposes in tandem with the Reserve Bank's new LVR restrictions targeted at Auckland rental property investors "may be undesirable if it results in overkill."
But in the end of the Government chose only to impose a two year 'bright line' test for taxing capital gains as income to rental property investors and to force resident and non-resident investors to declare their IRD numbers to Land and Information New Zealand.
Treasury said Auckland house prices could be judged to be "fair value" if interest rates remained near current record lows, migration rates remained near current record highs and housing supply issues were not resolved.
"If we assume that migration trends reverse or cheaper supply is gradually brought on stream or interest rates rise significantly, current prices look less reasonable," Treasury said.
It then listed other indicators "that the Auckland property market exhibits some features of unrealistic expectations", including:
1. the highest ever price/rent ratio in history in New Zealand,
2. the highest ever price/income ratio in history in New Zealand,
3. media stories of investors making very large returns from holding property,
4. media stories of first home buyers "desperate" not to miss out at an auction and see prices move higher, and therefore bidding "whatever it takes,",
5. anecdotal stories of foreign buyers buying multiple properties in short time frames with very little due diligence,
6. international and domestic evidence that most housing investors simply extrapolate recent returns in the expectations of future returns, and very high recent returns in Auckland.
Treasury said there were "bubble elements" driving unrealistic expectations for prices in Auckland.
"Our overall conclusion is that there could be a material impact from the announcements to the extent that unreasonable expectations are reset," it said.
Give the money to Auckland Council?
Treasury also discussed how the revenues from a 1% levy on rental properties could be collected and distributed, including the possibility the Auckland Council could manage the collections and retain some of the funds.
"If a levy is imposed on Aucklanders, it may be appropriate for the revenue to be available to the Auckland Council," it said, adding that if these revenues were 'hypothecated' in the same way as road user levies are directed to road building and maintenance, these levies should be directed to growth infrastructure for housing.
Treasury said the various measures suggested, including the levies and bright line test, could discourage investor activity financing new builds of apartments, but it concluded any impact on supply would be minor as prices were already high enough to encourage building.
'Downward pressure on prices'
Elsewhere in the documents, Treasury noted that the 'bright line' test and forcing all investors to supply their tax and personal details was "likely to place downward pressure on prices."
"We expect that part of the impact will manifest through offshore purchasers being concerned that their purchase will be reported to their domestic tax authority," Treasury said, adding the measure would strongly support New Zealand's international obligations to prevent money laundering.
Also in support of the two year 'bright line' test, Treasury pointed to rapid churn of of new developments in Auckland, saying 59% of all new properties built in Auckland between 2009 and 2013 were onsold during that time and 29% of all new developments in Northern Auckland were traded within three months.
How to collect a mortgage levy and what it might do to prices
Treasury also looked at the mechanics of collecting a mortgage interest levy (possibly by banks) and how much interest could be declared unavailable as an expense for tax purposes (50%).
It said a 2% levy on all the principal borrowed could be applied for three years, with a temporary exemption for new builds.
The 2% levy could reduce a rental property's value as an investment to a 70% geared investor by 4%, while a 50% reduction in interest deductibility would reduce the property's value by 19%.
Given investors made up about 28% of buyers, Treasury estimated the 2% levy could reduce market prices by 1.1% and the 50% interest deductibility change could reduce prices 5.3%.
Treasury estimated that such measures would see some renters become home owners, meaning any increase in rents would be marginal, although there would also be a marginal increase in over-crowding.
Treasury in the end suggested the Auckland Investor levy of 1% would be better than either a mortgage interest levy or reducing interest deductibility from 100% to 50%, given the logistical problems collecting the mortgage levy and the distortions in changing the interest deductibility rules, particularly for other forms of business.
It acknowledged an Auckland Investor levy on capital values would likely lead to a rise in rents.