Market Impacts of Brightline and Interest Deductibility Changes.

Last month, we speculated on the detail of the tax changes based on IRD commentary. Most people will now be aware that the bill heralding the changes has finally been released on the eve of the deductibility of interest being removed on 1 October. 

Much of the detail was as anticipated with a couple of minor surprises. 

The first being that the definition of a new build will include anything gaining a CCC after 27 March 2020 rather than March 2021, effectively back dating this a year. Good news for people who finished a project after this date but still leaving those with new builds finished before this with no interest deductibility. 

Another interesting quirk is the 20-year timeline for deductibility that will be passed from property owner to property owner. This will create the need to track yet another day count and will no doubt need to feature as a warranty in Sale and purchase agreements in terms of how much time a buyer has left in the twenty-year deductibility window which is not reset as property passes from owner to owner. 

Whilst the bill will still go through a final consultation process, we now at least have a degree of certainty around how the rules will work. 

Based on this, its possible to start to consider what some of the market impacts of all this might be and think about some of the opportunities and challenges investors can now respond to. 

Whilst my own crystal ball is no better than anyone else’s, to follow, are a few thoughts and suggestions on what I think the market impacts will be and some strategies to respond with. 

Firstly, lets face facts. Nobody should accept a taxing outcome where they pay tax on an income that doesn’t exist without considering making change. 

Selling and deleveraging should at least be considered. 

The combined impact of rising interest rates and the removal of the deductibility of that interest on existing stock properties will have a major cashflow impact on investors. 

Use this clear and present threat as a motivator to review the actual yields you are getting on your properties relative to their values and consider the upside of deleveraging by selling low yielding properties. 

Not only will this strategy improve your actual cashflow, it will reduce the impact of the removal of deductibility. 

Right now, there is a distinct lack of listings and plenty of buyer demand so gaining a solid outcome that will make a material difference to your cashflow is there for the taking for many investors. 

Perhaps this is step one of a strategy to then re borrow for a new build. Remember, a new build is not just a brand new acquisition. It includes converting one dwelling into two flats. It also includes subdividing an existing property and adding a new minor dwelling. Subdividing also comes with the added benefit of no Brightline reset. So the message here is consider polishing some of the gold nuggets you are already standing on. 

If you are considering a new build, pause and think. Yes, the 5 year Brightline and deductibility are great but are you paying a premium for the property when compared to an existing one ? There are also a lot of inexperienced developers entering the fray and warnings from the construction industry about shortcuts being taken. Consider the supply chain and labour shortages and think about whether construction contracts can be repriced if prices rise. Also remember you can’t lock in an interest rate on a new build until completion and rates are sure to rise. 

Think a little bit about the artificiality that these tax changes are going to create in the market. There will be huge numbers of infill terrace houses being built in response to the tax incentives, but current projections are that population increase does not demand this level of building. We could easily end up with an oversupply. 

I worry that should that happen, the government may not repeal their tax policy because to do so might be viewed as a political change of heart, so the lever that was thrown today to distort the market will almost certainly have an unintended consequence tomorrow if its left in gear too long. 

Each lovely old bungalow on a corner site in a leafy suburb that is removed to make way for a cheap terrace house development is one less that will be available to those looking for a large traditional home on a decent piece of land. These sorts of properties, despite being existing stock, are probably the sort of thing that will stand the test of time and gain value through scarcity. 

Lastly, pause to consider commercial property investment. No loss ring fencing, no Brightline, no limit on deductibility or interest and would you believe, even a tax deduction for depreciation on the building. 

Sound like the good old days? Well, that is still the tax reality of commercial property, which could be as simple as an eighty-thousand-dollar carpark. 

Yes, the prices have risen as yields have fallen but they are still typically better than residential combined with the advantage that on net leases the tenant pays the outgoings. 

Could now be the time to roll up your sleeves and sell some of those low yielding residential Properties currently funded with debt that is non deductible any buy some higher yielding commercial that has none of the tax problems associated with it.