New Zealand doesn’t have a true capital gains tax when it comes to the property market (something that property investors, economists and central government are divided upon) but we do have a funny little piece of tax legislation called the Bright Line Test.
And there have been some big changes announced to the current rules in March, which have the potential to change the game for property investors and make it cool (and financially beneficial) to own multiple properties once again.
So what’s this “test” and how does it affect the market?
Put simply, the Bright Line Test requires income tax to be paid on the capital gain on a property between the time it is purchased and sold. But the most relevant part is the length of time an investor must wait before they are no longer required to pay tax.
The previous government, under pressure amid a red hot property market in 2020 and 2021, extended the bright line test out to 5 years for new build homes, and 10 years for existing homes. This meant that if a property was bought and sold within those time frames, there would be tax payable on any capital gain.
They also reduced the ability for residential property investors to claim the cost of loan interest as an expense to their businesses, a move that put a lot of highly leveraged owners under financial pressure.
In a simple example, an investor who may have borrowed $500,000 to purchase a property which received $500 a week in rent is now paying just under $35,000 a year in interest costs, and receiving just over $25,000 a year in rent. They’re covering an extra $10,000 year over and above the rent they receive, and with interest deductibility removed (or treated as if it doesn’t exist as an expense), they were also paying income tax on the rent, of around $8500.
Plenty would say this isn’t a bad thing, and that investors and developers had benefited significantly from the gains since Covid-19, but the reality we’ve seen has been the “Mum and Dad investors” battling to cover their tax obligations, and this in turn affecting the availability of rental properties in the market.
What has concerned me is that the supply of new rentals had dried up – and the incentives to build new, with cheaper lending options, weren’t large enough to cover the significant drop in yields for investors.
After all, we have to look at this like any business – is the return on the capital required to run the business significant enough to warrant the risk of purchasing a property in an uncertain market, topping up the mortgage, finding good quality tenants, and meeting all the government obligations? For many would-be investors, that risk was too high, and cashflow wasn’t there, so they chose to invest in shares, funds, or businesses.
The new government sees this differently and has made some big changes to the way they’ll treat residential property investors heading forward. They’ve reduced the Bright Line Test to two years rather than 10 years, and will phase interest deductibility back in over the next two financial years.
With surging migration and still a relative lack of new build properties as rising costs of building has slowed or put a stop to projects, property is still in demand, and it just got a little bit more attractive to own one.
Does that mean the housing market is going to surge? I don’t think so.
With interest rates till at decade long highs and most mainstream banks offering one year rates in the late six, there are still plenty of people who don’t meet the criteria for purchasing multiple properties, and few investors are seeing yields that match or get close to their expense costs to run a property.
But I do think the changes announced will support modest capital growth across our region in 2024-2025. The Official Cash Rate is expected to decline in the coming years and that will relieve rate pressure from most households.
So while the horizon isn’t likely to bring sunshine and rainbows anytime soon, there are bright sparks out there we certainly can’t ignore.
