Housing tax changes – will they lead to a leap in rents?

There have been a wide range of people saying that the changes to the tax treatment of property will lead to a leap in rents.  So will it?

I would say that the answer is yes, and no.  Here is why.

There is no reason for rents to go up immediately

One of the claims I keep hearing is that rents will have to rise immediately, so that investors can keep making the same rate of return on property.

Now it is true that, in the medium term, we would expect the yield on property to sit at some sort of level – and the increase in taxation on property will have an impact here.  However, the “yield” can be improved either by an increase in rents or a decrease in house prices – as a result we don’t have any mechanism to say what is going on quiet yet.

In fact, in the very near term the burden of this tax should entirely fall on landlords.  Why?  Well if a property investor finds that they aren’t happy with the rate of return once the tax has gone up they could do three things:

1. Leave the house empty,
2. Accept the lower rental yield,
3. Sell the house.

Now assuming that the first option is not going to happen, then in a static sense these decisions have no impact on the level of rents.  The second option has the landlord continuing to sit there and set their rent to maximise their yield, subject to possible constraints with tenants (eg a discount because they have a tenant who has revealed their quality, a case top companies like Austin Tenant Advisors dealing with).  The third option has the investor leaving the market – so there are fewer rental properties.  However, they either sell the house to another investor, a current owner occupier (who must sell their own house, or become an investor), or they sell to a renter – reducing demand for rental properties.

In the “static” sense, there is no reason to think we will see a significant lift in rents.

But

There are two issues here.  Firstly, the landlords may use the tax change as a “co-ordination device” in order to all increase rents at the same time.

If we have a situation where the equilibrium rent is not unique, the fact landlords have convinced themselves that rents should be higher could end up with higher rents – as the willingness of a tenant to pay for a “housing service” depends upon the cost of receiving that same service somewhere else.  Of course, at the margin you would expect some renters to move out and purchase houses, but as we said before this would only reduce rental demand insofar as it reduces the rental stock (and it would lead to upward pressure on house prices) – and so this would imply that the value to the marginal renter would infact be higher in this case.

Still, this seems like a bit of an out there situation.  The more important one is:

Building

An effective increase on the tax on residential investment will lead to lower residential investment.  Lower residential investment will lead to higher rents.  That is fine.

Now, if we were to discuss welfare consequences, I would point out that NZ was implicitly subsidising residential investment in the past – something everyone decided we shouldn’t be doing.  So where’s the problem?

The conclusion is, as a direct result of these tax changes house prices will be lower and rents will be higher.  However, given that one of the countries main “imbalances” was that it overspent on housing (overspent and yet barely kept up with the necessary housing stock!), it is probably fair to say that the tax changes were a step in the right direction.