Bayleys sees rising rents, tougher times for property investors

Rents charged for houses and offices will rise and many property investors won't be able to absorb the removal of tax depreciation on investment properties, according to Bayleys Valuations' John Freeman. Freeman noted effective from the 2011-12 income year depreciation deductions will no longer be allowed for buildings with an estimated useful life of 50 years or more.

“I believe that property investors and owners will not be happy to, or indeed in many cases able to, absorb the changes in depreciation expense claims on their properties," Freeman said. "That will probably reduce net income from the investment so there will have to be movement on rental levels, and the only way investors can maintain yield margins is by increasing rents.”

Freeman said the Government had decided buildings don't drop in value over time, therefore property owners have an unfair tax advantage. Click here to read Bill English's budget speech.

“The tax depreciation rate basically effective for most property investors on buildings from April 1, 2011 will therefore be reset to zero.” “That is unless of course in accordance with IR 265 (the IRD’s tax depreciation rate guide) you own a portable building or one with prefabricated stressed-skin insulation panels. If you currently do have a building that meets this ‘less then 50 year useful life’ criteria, you can continue to depreciate it at the current rate."

Budget estimates the changes to tax on property investment will raise NZ$685 million in 2011-12 and NZ$690 million in 2013-14, Freeman notes. Furthermore the Inland Revenue Department has been allocated a “significant boost in funding” to help it audit property transactions, and to increase its “debt collection and the hidden economy.” Meanwhile Loss Attributing Qualifying Companies or LAQCs, used by many residential property investors, will also be treated differently from next year.

“The 2010 Budget has signaled legislation is to be proposed that from April 2011, all LACQs will be taxed as limited partnerships. Laws will be tightened from April next year to prevent investors choosing to have losses deducted at their marginal personal tax rate, but profits taxed at the lower company tax rate. “The Government feels this will ensure both profits and losses incurred are calculated at the same marginal tax rate as that of the investor. Investors should review these changes in conjunction with taxation specialists to determine the personal effect of these changes upon them and their investments vehicles.”

Freeman's examples: What the changes mean to property investors' bottom lines

Currently if an investor purchases a commercial property, such as an office block, with a cost (excluding the land component) of NZ$3.5million, without segregating it any further for tax depreciation purposes, then the first year’s claim is in the region of NZ$105,000. Segregated further into the buildings and services categories increases the current claim levels to approximately NZ$164,000.

The Budget action in removing building depreciation claims means an investor’s first year’s depreciation claim could be a maximum of NZ115,000. However if fitout allowances are - as is being signaled - reduced or disallowed altogether, this estimate would reduce dramatically. Investors who fail to segregate assets into their correct depreciation categories of buildings and services will see all their depreciation claims disappear from April 1, 2011. For a residential property investor purchasing a rental property for a cost of NZ$300,000 (again excluding land) basic tax depreciation claims allowable now are between NZ$6000 and NZ$9000 for the first year of ownership depending on the rate chosen. From April 1, 2011, most residential property investors - even allowing for segregating of assets into building and fitout/chattels categories - the figures will almost certainly disappear, and depreciation allowable claims will be significantly reduced. Investors buying and/or selling property in the future should be conscious that the IRD has more money and resources to spend on investigating the transaction to ensure the process is completed in total accordance with the all rules.

Meanwhile, BNZ chief economist Tony Alexander said the Budget marked the most important day for New Zealand housing market investors in many years with changes to the rules governing tax treatment of residential property investments. Alexander predicts the impact will be mildly negative for property prices in the next few months.

What will the impact of these changes be? They are largely as expected and to that extent the housing market will already have partly adjusted to them. But we suspect there will be many people reconsidering their portfolio with the result being fewer people buying investment properties and some looking to sell them. The impact over the next few months is likely to be some mild downward pressure on property prices. But as we have long noted we are not building enough houses in New Zealand and investors will now build even fewer. We expect this growing imbalance between demand and supply to restrict price declines (as they did over 2008-09) and lead to mild rises again over 2011. But truth be told, it will take a while to gauge exactly how many investors will change their plans on the basis of the tax changes so the next few months will be interesting.

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