New Zealand Tried to Kill Negative Gearing. Here’s What Happened Next.

As Australia approaches its next federal budget, the nation’s property investors and policymakers alike are keenly observing economic indicators and potential policy shifts. Amidst this anticipation, a crucial case study unfolds across the Tasman Sea. Over the last four years, New Zealand implemented significant changes to its property investment landscape, particularly targeting the tax deductibility of interest on residential investment properties – a mechanism often referred to as ‘negative gearing’ in the Australian context. Understanding the ramifications of these reforms is paramount for every Australian property investor and anyone interested in the future of the housing market.

The Policy Shift: Targeting Investor Behaviour

In March 2021, the then-Labour government in New Zealand unveiled a suite of reforms aimed at cooling a rapidly escalating housing market, improving affordability for first-home buyers, and curbing what it perceived as speculative investment. A cornerstone of these changes was the phased removal of interest deductibility for residential investment properties. Previously, landlords could deduct the interest costs on their mortgages from their rental income, reducing their taxable income. This deduction is a key component of what allows properties to be negatively geared, where expenses exceed income, and the loss can be offset against other taxable income.

Specifically, for properties acquired on or after March 27, 2021, interest could no longer be deducted. For properties purchased before this date, the ability to deduct interest was gradually phased out, becoming fully non-deductible by April 1, 2025. An exemption was initially provided for new builds, a measure intended to stimulate housing supply, though the specifics of this exemption underwent subsequent clarifications and adjustments.

Accompanying this change was an extension of New Zealand’s ‘bright-line test’ – a tax similar to capital gains tax – from five years to ten years. This meant that profits from the sale of residential properties within ten years of purchase (with some exceptions) would be taxed at the investor’s marginal income tax rate, further disincentivising short-term speculation.

Immediate Market Reaction and Investor Sentiment

The announcement sent an immediate ripple through the New Zealand property market. Investor sentiment, which had been buoyant, saw a noticeable shift. Many existing investors faced the prospect of increased holding costs as their interest deductions diminished, potentially turning positively geared properties into negatively geared ones without the tax benefits. New investors, meanwhile, found the economics of property investment significantly less attractive.

In the months following the announcement, transaction volumes in the investor segment declined. Some investors, particularly those with higher loan-to-value ratios or tighter margins, began to exit the market. There was a brief period of price moderation in some areas, though other factors, such as record-low interest rates at the time and ongoing supply shortages, continued to exert upward pressure on prices.

Four Years On: Unintended Consequences and Market Dynamics

Fast forward four years, and the long-term impacts of these policy changes are becoming clearer, offering crucial insights for Australia. While the initial goal was to improve housing affordability, the outcomes have been complex and, in some respects, counterproductive.

Impact on Rental Supply and Prices

One of the most significant and widely discussed consequences has been the impact on the rental market. As investor costs increased due to the loss of interest deductibility, many landlords sought to recoup these expenses by raising rents. Simultaneously, the disincentive for new investors, combined with some existing investors selling up, contributed to a tightening of rental supply. The result has been a substantial increase in rental prices across New New Zealand, exacerbating affordability challenges for tenants.

Housing Affordability for First-Home Buyers

The primary objective of improving affordability for first-home buyers has yielded mixed results. While house price growth did slow down and even saw a correction in 2022, this was also influenced by rising interest rates and broader economic headwinds. The fundamental issue of housing supply, which the interest deductibility changes did not directly address (beyond the new build exemption), remained a persistent challenge. Affordability, when measured against rising interest rates and stagnant wage growth, remained a significant hurdle for many aspiring homeowners.

Investor Behaviour and Market Stability

The policy changes undeniably altered investor behaviour. There was a noticeable shift towards investing in new builds, which retained the interest deductibility exemption, thereby supporting the construction sector to some extent. However, the overall disincentive for investment in existing properties contributed to a more volatile market for rental properties and potentially reduced the pool of available long-term rental housing.

Lessons for Australia’s Federal Budget

The New Zealand experience serves as a stark reminder for Australian policymakers contemplating similar reforms ahead of the federal budget. Australia’s property market shares many similarities with New Zealand’s, including high levels of household debt, an entrenched culture of property investment, and persistent debates around housing affordability.

Potential for Rental Crisis

Should Australia consider significant changes to negative gearing or capital gains tax, the New Zealand case suggests a high risk of exacerbating the current rental crisis. Increased costs for landlords are often passed on to tenants, while reduced investor participation can shrink the pool of available rental properties, driving rents higher.

Impact on Housing Supply

Unless carefully calibrated with robust measures to stimulate new housing supply, simply discouraging investment in existing properties may not solve affordability issues. Instead, it could create new problems in the rental market without fundamentally addressing the supply-demand imbalance.

Economic Stability

Major tax changes to a sector as significant as residential property can have broad economic implications, affecting construction, employment, and consumer confidence. Policymakers must weigh the potential benefits against the risks of market instability and unintended economic consequences.

Conclusion

New Zealand’s bold experiment in reforming its property investment tax settings offers a compelling and cautionary tale. While the intent to cool the market and improve affordability was clear, the execution led to complex outcomes, particularly for renters. As the Australian federal budget looms, the experience across the Tasman provides invaluable lessons: that changes to property investment policy, especially those touching on tax deductibility, can have profound and often unpredictable effects on rental markets, housing supply, and overall economic stability. Any proposed reforms in Australia must be thoroughly scrutinised through the lens of New Zealand’s four-year journey, ensuring that solutions to one problem do not inadvertently create or worsen others.

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