Keith Rankin Analysis – Empty Rentals and ‘Investor’-friendly Taxes

Analysis by Keith Rankin.

On Monday morning on RNZ’s Morning Report, Revenue Minister Simon Watts admitted that it was a legitimate option for ‘landlords’ to leave their houses empty. (Refer Revenue Minister on mortgage tax deductions for landlords, RNZ 11 March 2024.) The official narrative of the elite political class is that when tenancies on rental properties end, the houses are retenanted or sold; sold either to an owner-occupier or to a landlord who lets the property to new tenants. They don’t usually admit to owning homes which are fully or substantially empty.

I might also mention that, in one of the leaders’ political debates before the 2023 election, both Chris Hipkins and Christopher Luxon were asked a question about whether they favoured a tax on owners of empty houses. Both leaders appeared discomforted, as if this was a naughty question that should not have been asked, and then recombobulated themselves by saying ‘no’; a response that was to be expected from Luxon, but which may have cost Hipkins a significant number of votes. (In addition to not including such an obvious policy in the Labour manifesto, Hipkins’ cold rejection of an empty-house tax revealed that Luxon is not our only tone-deaf political leader.) Clearly neither leader had been briefed on the issue, despite such taxes being adopted overseas and despite the policy idea circulating widely in the New Zealand non-mainstream media.

An additional feature of the Simon Watts interview was the Minister’s defensiveness towards Corin Dann’s use of the term “property speculator”. When Dann pressed Watts on the matter, Watts was unable to deny that some so-called ‘investors’ were indeed ‘speculators’, and sought to fudge the issue by saying that typical ‘landlords’ are ‘ma and pa investors’ with just one or two rentals (presumably in addition to their ‘ma and pa family home’. This seems at odds with his earlier admission that professional investors have a valid option to leave rental properties untenanted; because the popular image of ‘ma and pa’ landlords is of people housing tenants who they know and have a relationship with, not an image of ruthless speculators.

It is worth reminding ourselves about maverick economist Gareth Morgan’s 2017 comments about residential landlords: see A hard look at Gareth Morgan’s plan to save New Zealand’s renters, Madeleine Holden, The Spinoff, 9 August 2017. Quote from Morgan: ‘”Look at me, I own six houses, ” he stated on The Nation. “I don’t have tenants; they just make carpets dirty. I do it because I know you [other investors] want to get in on this as well, and so you’re going to bid the price of those houses up.”‘

Leverage: how it works to create speculator paradise

Ruthless property speculators – of which there were many from 2003 to 2008 and again from 2011 to 2017 – use the principle of financial leverage to get a return principally from capital gain. (Capital gains taxes in other countries did not stop this process.)

The context is that New Zealand’s housing crisis is principally one of market and government failure in private rental housing. And we should note that this failure is less an Auckland problem and more a problem of New Zealand’s provincial cities and towns, and Wellington. Additionally, it is a crisis of urban land prices, and – as in the later 2000s – a crisis aggravated by high interest rates. Into this mix we face a change to taxation which will aggravate rather than diminish the housing crisis.

The principle of financial leverage works like this. Mr S has a million dollars and wants to double his money in two years. He has been told by his financial adviser that residential property is appreciating in price by ten percent a year. Further a typical house costs one million dollars. Mr S buys five houses with his million dollars; that $200,000 per house of his own money. He borrows the remaining four million dollars. (He may then list his houses on Airbnb, as ‘short-term’ rentals; he may even let his properties to genuine tenants, or he may leave them empty.) In two years time he expects to sell all five houses for 1.2 million dollars; that’s six million dollars in total. After repaying his mortgages in full, he would get to keep two million dollars. That’s a doubling of his initial outlay of one million. (OK, there will be some expenses; nevertheless Mr S expects to be smiling all the way to the bank when he realises his near 100% capital gain over two years.

Mr S is an example of a leveraged landlord. And he will make even more money if he doesn’t have to pay tax on his mortgage interest ‘costs’. But not all landlords are that highly leveraged. Some are not leveraged at all; they are letting mortgage-free properties to tenants. These landlords cannot gain from the deduction of tax for mortgage interest costs. So, in the coming years, they will not charge lower rents on account of lower costs. And it is these unleveraged landlords who will set the market price for private residential rental houses. (And many of these price-setting landlords will be ‘ma and pa investors’ approaching retirement age.) The leveraged landlords, if actually renting out their properties, when setting rents will take their cue from the unleveraged landlords; therefore, they will accept the reinstated tax deductions as windfall profits.

Rents will be at whatever price the market will bear, and not discounted by individual landlords with falling tax costs.

Auckland Regional Fuel Tax

Something similar will most likely happen with the repeal of the Auckland regional fuel tax. At present with the regional fuel tax in place, petrol prices in Auckland are not much different from the rest of the country. That wider nationwide price will tend to be the main determinant of ongoing petrol prices in Auckland, meaning the petrol retailers will gain a windfall when the tax ends. Auckland petrol consumers will gain less than what Mobil and BP will keep.

More generally, we see a pattern from this government to replace proportional taxes with regressive charges; for example, favouring increased car-registration fees over fuel taxes. The cost burdens are increasingly placed on those least able to afford the costs. (This situation can also occur if fixed charges for water or electricity increase faster than usage charges.)

House Prices

The granting of a licence to speculate is likely to set-up the next round of residential property price appreciation. (My sense is that other global economic headwinds will limit the next property bandwagon to no more than three years.) The issue today is much as it was in 2005, with the downturn in the tradable economy, caused in large part by higher interest rates, pushing bank lending into the non-tradable economy, especially property.

Lending to the property sector is less sensitive to interest rates than lending to businesses which export or compete with imports. The New Zealand economy is now primed for a shift in lending towards the property sector. In addition, consumer lending will likely stay strong; this will be driven more by the budget shortfalls of financially stretched households than by interest rates; consumer lending is largely interest-insensitive.

As house prices rise, rents can be expected to rise as landlords – unleveraged and leveraged – seek to maintain their percentage yields on capital. Let’s say that the expectation is that a $500,000 house in the provinces is expected to yield a rent of $500 per week; landlords’ expectations would be that if the $500,000 house becomes a $600,000 house then it should earn a rent of $600 per week. (In reality, in times of property price booms but little employment growth, there is quite a lag in rent increases; renters are simply unable to pay such proportional rent increases.)

What is likely to happen in the next few years – when the speculator community has its mojo back following the removal of tax on mortgage interest – is rents increasing faster than they otherwise would.

‘Investors’ owning just one home.

There is one class of landlords who require special attention. This is people who own just one home, which they rent out to tenants, while themselves renting their own dwelling.

I was in this situation from 2009 to 2014, having received an inheritance a few months after moving into a rental house which particularly suited my family’s circumstances. Other people will be in this situation if they move out of their family home to accept employment in another city. And other people, wanting to own some property as a hedge against poverty, will want to buy a cheapish rental in another town or an outer suburb; yet will themselves want to keep renting closer to where they work or to where their children go to school.

These people should pay zero tax on their rental income if the rent that they pay is more than the rent which they earn. While there is a case to treat mortgage interest as a legitimate ‘business’ cost for property owners, if the rent they pay offsets the rent they earn, then the question should not arise; there is no income to tax. So the critical reform here, that the National Party should be leading the way on, is to deduct rent paid from rent earned. More generally, these ‘landlords’ – who own just one property – should be treated more as owner-occupiers than as investor businesses.

Fiscal Austerity? Despite tax repeals.

We are being promised public austerity alongside the tax repeals which foster increased private affluence for a few. Tougher times stifle the circular flows that underpin a prosperous economy; austerity begets more austerity in a downward spiral, until someone finally rediscovers Keynesian economics.

Cabinet Minister Tama Potaka unashamedly advocated “austerity” last week, on Newshub’s AM show (1 March 2024): see ‘Not a free ATM card’: Taxpayers won’t bear cost of saving Newshub, minister says | AM. (The ‘austerity’ quote comes 8’38” into the video-recording. Lloyd Burr, the interviewer, looks genuinely surprised at this candid admission.)

In relation to Potaka’s comment we have this on Newshub on 5 March 2024: Finance Minister Nicola Willis rules out increasing GST after Labour speculation. The web-story discusses public austerity in the light of Potaka’s comments. This interview was a response to Why Labour’s new finance spokesperson Barbara Edmonds thinks a tax hike could be on the cards on Newshub the day before. Nicola Willis knows better than Tama Potaka to avoid the ‘austerity’ word. But Nicola Willis is showing all the signs that she will be like her 1990s’ predecessor Ruth Richardson, who cut benefits and became Aotearoa New Zealand’s exemplar for fiscal austerity following her “mother of all budgets”.

Finally, Two questions for Christopher Luxon:

Prime Minister Christopher Luxon owns four investment properties as well as three residences.

Question: Are you a good landlord, Mr Luxon?

Supplementary Question: How many of your four investment properties are currently tenanted?

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Keith Rankin (keith at rankin dot nz), trained as an economic historian, is a retired lecturer in Economics and Statistics. He lives in Auckland, New Zealand.