Cullen: Address to Wgtn Property Investors Assn
Hon Dr Michael Cullen
Deputy Prime Minister, Minister of Finance, Minister of Revenue, Attorney General, Leader of the House
25 July 2005 Speech Notes
Address to Wellington Property Investors Association
National Library Auditorium, Aitken St, Wellington
New Zealanders have had a remarkable love affair with residential property. Perhaps it is something to do with our colonial forebears, who came here looking for a piece of land to call their own. Alternatively, the strong connection that Maori feel to the land has clearly had an influence on the whole of the Kiwi psyche.
Whatever the case, as a people we invest something in the region of 70 per cent of our net household wealth in residential property, as compared to an OECD average of around 50 per cent.
There are some good aspects to that. Owning one’s own home is an important platform for family well-being. It tends to make people more resilient when they encounter difficult times.
That is why this government has sought to encourage home ownership through various policies, including most recently the KiwiSaver scheme, which will assist people with the purchase of their first home in three respects:
First, an extension of the Mortgage Insurance Scheme, which assists people who have a good credit history and the capacity to support a mortgage, but limited ability to raise a deposit;
Second, a housing deposit subsidy available through KiwiSaver, which will provide assistance with a deposit in the form of a suspensory loan up to a maximum of $5,000; and
A home ownership education programme to assist first home buyers improve their understanding of what home ownership involves.
In providing this assistance we are conscious of the need to avoid distorting the housing market and encouraging people to borrow beyond their means. We believe we have the balance right.
It is not surprisingly that when Kiwis decide it is time to invest for the future, further property investments represent an attractive option, since it is something that is tangible and familiar, and it does not require dependence upon advice from professional investment advisors.
My government has always respected this as a choice that many New Zealanders make, having weighed up all their options. However, from a broader point of view we have made no secret of the fact that we would like to see an increase of domestic savings with diversification into a wider range of investment vehicles. We think it is important over time that we become a nation of share owners as well as, but not instead of, a nation of home-owners.
The reason why is partly prudence and risk management, and partly the need to boost the resources available for investment in New Zealand companies. To see why diversification is a good strategy, one needs look no further than the current outlook for the residential property market.
A weaker labour market and continued slowing in net migration inflows are expected to lead to a fall in residential investment in the next two years. The impact of higher mortgage interest rates (albeit delayed because of the high proportion of home loans which are at fixed rates) will also contribute to the fall.
In addition, residential rents have not kept pace with construction costs and house prices, with the result that returns from investment in housing are reducing. Like Auckland and Christchurch, Wellington has seen a rapid growth in the number of apartments; but that, combined with a downturn in the numbers of foreign students, has increased the risk of an over-supply in that part of the market.
Indeed, residential investment growth is estimated to have fallen to zero in the March 2005 year and is forecast to be negative in the 2006 and 2007 March years before stabilising after that. That is sparking a wider concern for the strength of the domestic economy since the fall in residential investment will also contribute to slower consumption growth, especially for consumer durables, such as white wear, which are associated with residential investment.
Having said that, the residential property market has a great capacity to surprise forecasters. Residential investment in the second half of 2004 was weaker than many expected, but it started to pick up later in the year and there are some expectations of a catch-up in the first half of 2005.
Two factors may be muddying the waters. The first was the ‘mortgage war’ amongst major lenders which reduced average mortgage lending margins in November and December 2004. The gap between the two-year wholesale swap interest rate and the 2-year fixed mortgage interest rate for new borrowers declined to 60 basis points, compared to an average since 1999 of 110 basis points. It is quite likely that this mortgage war contributed to increased house sales and house building approvals.
The other factor is the change in building regulations which took effect at the end of March 2005. There was a significant increase in the number of consents granted during March, possibly because builders were aiming to get projects approved under the old regulations. Consistent with this hypothesis, a sharp decline in consent numbers followed in April with only a partial rebound in May. However, some anecdotal reports suggest that the April and May declines have been due to consent applications being returned to applicants for remedial work, rather than demand slumping.
The anecdotes of a backlog of work which has built up in the housing construction industry (chiefly because of the shortage of skilled trades people) also suggest that residential investment in the first half of 2005 may be higher than envisaged.
However, there is every possibility that it will be a false dawn. The outlook for the next few quarters is that economic growth will slow. Meanwhile, interest rates are not predicted to change markedly, and population growth is expected to be slower than in the recent past because of reduced immigration. This will push down the demand for housing.
Sales and prices are both expected to lose momentum, notwithstanding the recent upward trend in prices; and the number of new houses built is expected to decline.
None of this should be much of a surprise. It has become a common view that the recent rate of house price growth is unsustainable. Downward adjustments will allow household debt servicing burdens to stabilise, and will bring rents and building costs closer to house prices, which is the expected long-term relationship. It will also prevent over-supply in the housing sector.
Despite all of this, property remains an important element in a well-chosen investment portfolio. From time to time there are calls to introduce various forms of property tax in order to achieve the much-vaunted ‘level playing field’ amongst different asset classes.
As you are aware, the main concerns raised with respect to property are that mortgage-free home ownership provides owner-occupiers with the benefit of an imputed rent and that capital gains go untaxed. The government’s view is that New Zealand’s income tax base is one of the cleanest in the OECD.
The Tax Review 2001 considered whether capital gains should be taxed on a more comprehensive basis by introducing a separate capital gains tax. They concluded that the disadvantages of a comprehensive tax on capital gains – increasing the complexity and the costs of the tax system – outweighed any theoretical benefits from including the gains in the tax base. The government agrees with this analysis.
So our position on the taxation of property is that the status quo is quite adequate, and that, all things considered, change does not promise significant overall benefits. A level playing field is, after all, only a theoretical concept. Real playing fields have their soft patches, slight tilts and areas of subsidence. Within certain limits, the players learn to work around them without affecting the quality of the game.
In other words, any new form of property tax is off our agenda. In our judgement there is more than enough scope to ensure that the tax system provides New Zealand investors with a largely neutral investment environment.
Having said that, can I say again that we want to see greater diversification amongst New Zealand investors. We will encourage that in a number of ways:
The KiwiSaver scheme provides modest incentives for employees to make regular contributions into an approved work-based scheme. These are not tax incentives, but rather an upfront contribution from the government and ongoing assistance with administration costs. Our aim with the scheme is to strengthen the savings habit in New Zealand so that more of us have a stake in the growth of our economy that extends beyond the labour market.
Alongside KiwiSaver we are funding information and education programmes aimed at improving the level of financial and investment literacy amongst ordinary New Zealanders. We have overseen five years in which the real incomes of New Zealand households have risen by around 11 per cent. We want to ensure that New Zealanders have a higher level of skills to manage that wealth.
We have recently received the report of the Webb Taskforce into the regulation of financial advisors. This contains a number of suggestions for improving the quality and independence of financial advice available to New Zealanders seeking to access the retail savings industry.
I said at the outset that New Zealanders have had a remarkable love affair with residential property. Where the Labour-led government is heading is to broaden those investment patterns and to promote a stronger and more savvy savings culture.