Auckland Uni think-tank challenges Tax Working Group's NZ$200 bln figure for rental properties (Update 2)

Watch an Economic Housing Report on our video page here Watch on YouTube here Auckland University's Retirement Policy and Research Centre (RPRC) has challenged the Tax Working Group's (TWG) assertion that New Zealanders have NZ$200 billion invested in residential rental properties, arguing the actual number is less than half that. (Updated with further comments from Michael Littlewood on why he would prefer better IRD policing of current laws to new taxes) The RPRC has released a briefing paper examining the NZ$200 billion number, which was a central figure in the TWG's call for reform of the tax rules around property investment. The TWG argued that property investors made losses of NZ$500 million on that NZ$200 billion of property in 2008, creating NZ$150 million of losses in tax revenues and justifying changes to tax rules. "The TWG gave no source for the $200 billion investment, but suggested that the tax system needed change to reduce this apparent over-investment by households in this sector," said RPRC co-director Michael Littlewood (pictured left), adding New Zealand does not have good information on home ownership. “The TWG took what was effectively only a passing comment on a possible level of rental property investment and has turned that into a reason for changing the tax system” Littlewood said. The RPRC's briefing paper suggests rental property was more likely to be worth NZ$60 billion to NZ$100 billion. "New Zealand needs better quality information than was offered by the TWG on this apparently crucial point," Littlewood said. “If the true number is between, say, $60-$100 billion, New Zealand can start a discussion about that level of investment. If it is deemed ‘inappropriate’ then perhaps we need to consider changes to the income tax system that apparently encouraged that over-investment. If the true number is in fact deemed ‘appropriate’ then changes to the income tax framework might not be needed on that account alone,” he said. 'There's another way' Littlewood later told Interest.co.nz said the Inland Revenue Department should have policed the current laws on property trading more aggressively. "I don't think the IRD has been doing its job in this area. People have been buying and selling homes and they're not paying tax on the gains," Littlewood said. Rather than apply a 'bright line' test for property traders of, say, two years, Littlewood said IRD could look at other tests for whether a property investor was a trader rather than a long term investor and use its discretion in grey areas. "If you are borrowing more than a third of the value of the home, that shows the intention of buying for gain," he said. Littlewood rejected the idea that New Zealand investors had chosen en masse to make losses on property for the sake of tax reduction. "I don't believe it's possible for a whole nation to be irrational," he said. Not so much Littlewood said data from Household Savings Survey (HSS) produced by Statistics NZ and the Retirement Commission in 2002 showed rental property was worth just NZ$18.9 billion or 10.4% of total assets. Given house price inflation of 202% since then, this suggested rental property was now worth NZ$38.2 billion, he said. "It is unlikely that the house-price adjusted 2002 HSS number ($38.2 billion) would have grown to NZ$200 billion in only nine years. There may have been an increase (anecdotal evidence supports that) but a 523% increase (20% a year, compound) seems implausible," Littlewood said in the paper. Reserve Bank figures on the value of housing showed the total housing stock was worth NZ$569 billion at the end of 2008. If the TWG's NZ$200 billion number was correct, then 35.2% of the value of all housing assets would be rental property investments, he said. The paper went on to say:

There are two likely problems with that proposition: a. The 2002 HSS found that only 10.4% of all housing assets in 2001 were residential rental investments. It seems quite unlikely that the proportion of rental properties in households‟ balance sheets would have increased from 10.4% of all housing assets to 35.2% in only nine years. b. Secondly, if the 2002 HSS proportion of 10.4% were applied to the Reserve Bank‟s total housing investment in 2008, the implied value of rental properties in 2008 would have been $59.2 billion. That seems more consistent with the 2010 adjusted value of the HSS number arrived at above ($38.2 billion). If both those numbers are correct, that would indicate a 55% increase in the real value of investments in residential rental properties over the nine years since the 2002 HSS data were collected. That is a more credible increase than the 523% referred to above.

Littlewood said GDP figures for 2007 identified spending on housing improvements indicated only 28.9% of spending was on non owner-occupied housing. He then went on to challenge a paper cited in the Tax Working Group report by Motu economists Andrew Cole and Arthur Grimes. Here is the Cole/Grimes report referred to. Littlewood said the Cole/Grimes research had relied on flawed census data and an assumption that owner-occupied and investor-owned property were, on average, of equal value.

The acknowledged difficulty with average values is only part of the problem with this way of calculating the amount New Zealanders have invested in rental properties. There have been long-run and significant difficulties with using Census data to make any definitive judgement regarding the proportion of homes that are owned by their occupiers.

He said problems with census data were looked at in detail an RPRC paper published in 2008.

In summary, the difficulties are created by: - The presence of family trusts and the uncertain way in which the 2006 Census questions attempted to discover that; - The failure of Censuses since 1991 to measure accurately unoccupied housing: whether that is holiday accommodation, vacant rental housing or unsold properties; - The inconsistent way in which retirement housing is classified.

Littlewood said Grimes and Coleman appeared to have made assumptions from the 2006 census about the percentage of rental properties. He said they had used data showing who owned their properties directly or via trusts (62.71%) and then assumed the rest (37.29%) were rentals. Littlewood said 12.59% of the properties counted as rentals by Grimes and Coleman "could fit into the "owner-occupied" (category) if only the Census had been able to establish the true ownership position." Some could be in family trusts rather than in rental ownership, or be provided by employers. Others that were counted as 'not stated' had been assumed to be rentals, he said. Others may also be holiday homes, state-owned houses or unoccupied houses, rather than rentals. Littlewood concludes with this:

In summary, the 2006 Census showed that occupants were paying rent in respect of 23.7% of all dwellings. We do not know whether the amounts paid were market-related rents so even that statistic does not necessarily mean all 23.7% were owned at arms length from the occupiers. About 5.2% of all dwellings were owned by the government or local authorities. That leaves at least 18.5% as apparently owned privately in the form of rental investments. It is likely that there were more rental investment properties than that on Census night (for example, empty properties between tenants) but the total proportion of rental investment properties is more likely to be closer to 20% than the TWG‟s assumed 37.3%. Given that, as noted by Coleman & Grimes, the average value of rental properties is likely to be somewhat less than the average value of all privately owned housing, the proportion by total value could easily be less than 20%. The TWG‟s 2010 report has apparently taken what can only be described as a very rough estimate of the value of "investor-owned residential‟ property of $213 billion and rounded it down to the cited $200 billion. These smaller numbers put into a more useful context the somewhat dismissive comparison made by the TWG with the total value of all listed shares in New Zealand of "only" $55 billion. The difficulties with the $200 billion number need to be considered in any potential changes the government is contemplating in relation to the tax treatment of residential property investments.