The characteristics of residential property as an asset in one’s portfolio have changed. That does not mean there is about to be a wholesale dumping of this asset. But it does suggest a slow repricing over time.
Every asset has risk attached to it. The higher the risk of losing all or a portion of one’s investment, and the greater the potential volatility in year-to-year returns, the lower the price that a new investor will offer and the greater the ongoing return that they will demand.
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Thus, interest rates which companies offer on bonds sold to investors are higher than interest rates offered by governments and local authorities because of the greater risk the company will collapse or default on payments.
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Shares of companies with highly volatile earnings tend to deliver a higher yield than other shares because of the enhanced risk of loss.
For residential property, the nature of this investment has been changing and now has altered in a way clear for all to see. The Government has shown that it is prepared to radically alter the returns of holders of residential property assets in order to pursue social goals and effectively make private owners of residential property part of the state’s housing provision network.
In recent years costs have been pushed higher through the likes of Healthy Homes legislation. Flexibility in managing the asset has deteriorated courtesy of limits on frequency of rent changes, and reduced ability to move out undesired tenants.
Now, the Government has altered the tax position of residential property as an investment. Having done this once there is a high chance that they will do it again down the track if they again do not feel their social goals are being achieved. In addition, already there is talk by the Finance Minister of new controls on rents. Plus, there are expectations that the potential flow of new funds into this asset will be reduced by the likely imposition one day of restrictions on interest-only lending and probable introduction of debt-to-income limits on borrowing.
It cannot be taken for granted even that the retention of the brightline test on new builds to five years will remain, or that the ability to deduct interest costs for new builds will be allowed to continue if desired social goals are still out of reach.
None of these things mean that residential property is an asset to be avoided. They just mean that it needs to be repriced. If these changes were being applied to an asset traded on the likes of a sharemarket we would have seen its share price fall and new offerings of similar shares have to include a higher yield than otherwise.
So, what will be the repricing of residential property to reflect the most recent changes, the alteration in its risk profile, and the probability of further controls to come?
New investors will demand compensation for added risk. That means they will be prepared to pay less for the asset than before. There will be downward pressure on the prices of properties brought to the market which could be classified as an investment. That probably means everything below and just above the median sales price in every location.
The demand for a higher running yield because of heightened risk will mean existing investors will lift rents while new investors will plan to charge higher rents than would otherwise be the case.
Will these things happen quickly? No - for two reasons. First, for investors in newly built property the only change so far is higher risk of future intervention, not current imposition of changes reducing anticipated returns. However, the incentivising of investors to purchase new rather than existing property will eventually push up prices which developers can charge for new units, thus depriving some first home buyers of access. Second, for existing asset holders the tax changes will be phased in over four years.
Does this mean there will be no market impact? No. We should expect that because the costs of running a residential property investment business have gone up, selling prices – in this case rent – will rise while the volume of product offered (the rental stock) will decline, or grow less rapidly, than otherwise. And we should expect that in the short-term average house prices will take a downward correction.
In fact, in my latest mortgages.co.nz & Tony Alexander Mortgage Advisors Survey, to be released this week, a sharp falling off of investor demand is already apparent. The same result is apparent in my survey with the Real Estate Institute of New Zealand, coming out after Easter.
Note one thing to keep in mind. At the same time as foreign tourists return over 2022 and 2023 wanting motels to stay in, the state house waiting list will blow out. A panicked Government heading into the 2023 election is likely to offer some generous long-term leases to private providers to add to the social housing stock.
- Tony Alexander is an economics commentator and former chief economist for BNZ. Additional commentary from him can be found at www.tonyalexander.nz
