Let's not snuff out European-style rental options just as they're getting going

Friday, 9 July 2021

Key details of new tax rules are still being grappled with.

ANALYSIS: It would be a shame if a drive to provide more secure European-style rental accommodation options for middle-income New Zealanders hit an obstacle just as it seemed about to take off.

But there does seem some risk of that happening if the Government doesn’t show a bit of love to a new class of property developer building housing complexes with flats and units for long-term rental.

Revenue Minister David Parker gave a rather depressing description of the housing market in Parliament on Thursday, suggesting the market was divided between home-owners and reluctant renters.

“Renters generally cannot afford a mortgage, otherwise most of them would choose to buy a house rather than rent it,” he said.

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That suggests a level of immaturity in the options available in the market.

There must be a large group of Kiwis who want the security that property-ownership provides, but without the ties, maintenance hassles, insurance worries, and sunk capital involved.

Arc’s Onehunga apartments have been built as long-term rentals.

Germany is one of the countries that caters for that group extremely well, with a preponderance of relatively high-density four-to-six storey housing complexes that people tend to rent in for decades.

It’s not everyone’s cup of tea of course.

But Kent Gardner, who returned to New Zealand from Europe three years ago, is one of a new generation of “build to rent” property developers trying to create more such options here.

“Basically it is where long-term, professional capital is brought to the residential rental market,” he says.

Arc has spent $40m to date investing in build-to-rent developments in Auckland, of which the first completed is a three-storey 48-apartment residential complex on Selwyn St in Onehunga, Auckland.

“The thing about build-to-rent is the properties are designed specifically for long-term rental with the idea that tenants or residents are customers who can stay as long as they like,” Gardner says.

Gardner says there is a “definite possibility” two more residential developments it has planned won’t go ahead without a government rethink.

“What we have seen in the rental market in New Zealand up to now with owners who own one, two or three rental properties is they change their mind.

“They decide to leave the market or retire, or a family-member needs the property, and that has led to poor outcomes for tenants.”

The Super Fund appears poised to invest in build-to-rent.

Its investment head Will Goodwin says it is interested in making more property investments, including in build-to-rent housing, which he describes as “an underdeveloped asset class in New Zealand and an area of interest for the fund”.

But Gardner says two new Auckland developments that it has in the wings have been put at risk by the Government’s proposed changes to interest deductibility rules, which could limit investors’ ability to offset their interest costs against their income.

Revenue Minister David Parker has signalled specific rules for new builds, could apply for 10 to 20 years to the building, not the builder.

There is a “definite possibility” they might not ahead because of the new rules, he says.

The Property Council says the feedback it has had from developers suggests the tax change will make it much more difficult for build-to-rent’s potential to be unlocked.

The Government has signalled it will continue to allow interest deductibility on “new builds”, potentially allowing investors in all new properties, including built-to-rent developers, to claim deductions for perhaps 10 or 20 years after they invest.

But the new rules could still hold back the sector, if that ability to claim deductions is lost on the earlier sale of a property.

The quickest way to get the built-to-rent sector firing on all cylinders would be for developers to sell their interests in the complexes they build to other investors once they are generating predictable cash flows and then recycle the proceeds into further developments.

If they instead need to tie up their own capital for 10 or 20 years to claim deductibility, that could be a brake on the sector.

National Party shadow treasurer Andrew Bayly says he doesn’t think the Government thought through all the implications of changing deductibility rules when it decided to go down that track in March.

Any obstacles it puts up against investment “mean we are not going to get the new houses we so desperately need”, he says.

There are indications the arguments are now heading towards some sort of fairly sensible resolution.

Renting is a more common long-term lifestyle option in Germany, where four-to-six storey apartment buildings are very much a norm.

Parker said in Parliament that the Government was considering tying interest deductibility on new builds to buildings, rather than the builder.

What that would presumably mean is that the right to deduct interest on new builds could transfer to subsequent investors in build-to-rent and other developments, at least until 10 or 20 years was up.

A more intellectually elegant approach might be to allow a transferrable entitlement to interest deductibility on new builds, capped at the original value of the investment, without any arbitrary cut-off date by which deductions would need to be claimed.

That approach might more neatly meet the Government’s objectives of trying to avoid discouraging new builds, while not allowing deductibility each and every time someone raised a loan to buy an existing property.

Either of these solutions would seem ‘OK”.

But Gardner and the Property Council have suggested that the Government go a step further and create a specific carve-out for build-to-rent investments from the new tax deductibility rules, treating them as a new asset class in their own right.

The council says a carve-out should also see such investments excluded from the provisions of the Overseas Investment Act, which could assist with the flow of post-build, flow-on capital.

It has suggested defining build-to-rent assets as accommodation portfolios comprising at least 50 self-contained dwellings dedicated to residential tenancies of at least eight years.

The natural inclination of politicians and officials will probably be to shy away from such bespoke solutions, and to fret about how such a new set of rules could be gamed at the edges.

But if we do really want to advance from the unsatisfactory state of affairs Parker described in Parliament, it may be worth considering.

The Property Council believes that with the right signals, we would see developers commit to build at least 20,000 new dwellings for long-term rental within the next 10 years.

We are talking here about 20,000 relatively high-density rentals, desirably located in suburb centres.

It might not be a bad moment for the Government to throw a bit of confidence into the market by showing a level of active support to make that happen.

If the Super Fund is comfortable describing ‘build-to-rent’ as an underdeveloped asset class, why not the rest of government?