Westpac says the Government's announcement to remove interest deductibility for investor properties tilts the balance "dramatically" in favour of owner-occupiers, but could result in house prices falling by 10 percent.
The Government announced earlier on Tuesday that it will remove the ability for property investors to offset the interest on residential investment properties as an expense against their income from those properties. This change will take effect from October 1, 2021 for properties purchased after March 27, 2021. For properties bought before that date, deductibility will be phased out over the next four years.
Michael Gordon, Westpac's acting chief economist, says up until now, the balance between owner-occupiers and investors always favoured the latter. However, removing interest deductibility tilts the balance in favour of owner-occupiers "who will now be the ones who determine the market price of houses".
"A rough calculation suggests that their average willingness to pay is about 10 percent below current prices, which suggests that house prices could fall by that much in the long term. That in itself is not particularly onerous - it would bring prices back to where they were four months ago," he says in Westpac's latest Economic Bulletin.
"However, there could be a much greater decline in the short term, while the housing market realigns itself. Without interest deductibility, property investors will need to see a higher rate of return to justify their investments. That could mean higher rents, although that will be constrained by tenants' ability to pay."
Gordon says the more likely way is that highly-leveraged investors will sell out, at a reduced price, to owner-occupiers or less-leveraged investors.
"We saw similar outcomes in the UK, which began to phase out interest deductibility from 2017. House price growth slowed to zero, rents rose to some degree, and housing construction slowed. More recently, the resulting shortage of housing had started to lift prices again, at least until COVID struck."
A property investor told Newshub on Tuesday that he also believes the Government's announcement to remove interest deductibility could be bad news for renters.
"All it does is make the supply of rental property go down and rental prices go up. I can't see that it's going to be in tenants' best interest," says Andrew King of the NZ Property Investors Federation.
Gordon says the removal of interest deductibility came as a "major surprise", but they had considered the possibility of a limit on deductibility, known as a thin capitalisation rule.
"There is already precedent for these rules in some sectors. The aim is to restrict leverage that serves no commercial purpose other than to reduce the tax bill," he says.
"We think that a similar approach would be appropriate for addressing the imbalances in the housing market. It would be a question of calibration, but it would be possible to tip the balance in favour of owner-occupiers without excessively disrupting the rental property market."