Peter Thompson Managing Director Barfoot & Thompson 26 May 2021

If Treasury’s forecasts in the Budget prove to be correct, the Government may well have found the key to taming rising house prices.

That key, according to Treasury, is the phased removal of the tax deductibility of interest rate costs from residential property investments.

When the removal of tax deductibility was announced in March, along with extending the bright line test and a $3.8 billion increase in the Housing Acceleration Fund, there was an immediate knee jerk reaction from many commentators.

Comments ranged from saying that investors would abandon the market through to house sales prices could collapse.

There were certainly no signs of that occurring in April’s sales data. The main trend showing up being the normal seasonal one that invariable occurs as we move from the high summer season to the less active autumn sales period.

Treasury, in its 2021 Budget Economic & Fiscal Update released with the Budget on May 20 (pages B3, 10 & 11), has a more restrained view of what will happen to house prices over the medium term, and its forecasting will give the Government hopes that it has found the right key.

Treasury is forecasting the rate of price increase in 2021 will be 17.2%, falling to 0.9% in 2022, and then increasing again to 2.1 in 2023 and 2024, and finally 2.5% in 2025.

While the fall from 17.2% to 0.9% is dramatic, the key point to note is that Treasury is not forecasting house prices falling over the next five years.

Rather it sees the ‘rate’ of price increase falling, and that is a far different thing to ‘prices falling’.

In fact, Treasury sees house prices steadily ‘increasing’ over the next five years, albeit at a lower rate than it was forecasting prior to the March announcements.

By 2025 it now sees house prices being 4% lower than if the changes had not been made.

While Treasury sees the removal of interest deductions as the initiative which will have the ‘largest impact’ on house price growth it is not expecting an exodus of investors from the residential housing market.

Rather it sees “highly leveraged investors being more impacted than those that are less leveraged, implying that higher leveraged investors will demand fewer homes going forward. Furthermore, existing property owners facing higher tax costs may seek to divest to bring overall costs down”.

This is a rather more orderly adjustment to change than being bandied around in the aftermath of when the changes were announced.

If what Treasury is forecasting occurs then stability will return to prices, and that will in the long-term be good for vendors and buyers, and the economy overall.

But taming house price increases does come with a short-term cost, and Treasury notes that the changes will result in a slower economic recovery than otherwise and it will prolong the period of monetary policy support needed to raise inflation and employment.

Will things pan out precisely the way Treasury is forecasting and the Government hopes?

Market experience says that such a sharp decline in such a short space of time (17.3% to 0.9%) is highly unlikely particularly given the many variables still in play.

These include the tax deductibility for new builds; the eventual opening of the borders which will lead to population growth (even if modest); low mortgage interest rates (which will still be low in an historical sense even if modest increases in rates occur) and the gap that exists between house demand and supply.

With the decline forecast to occur over the next 12 to 18 months, we will not have long to wait before we see how accurate Treasury’s forecast is.

What the 2021 Budget has done is, for a short period at least, lock in new ground rules, which will start to remove the uncertainty that has been abroad since March.

That is positive, and hopefully the market will now be left to find its own balance through to year end.


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