By Michael Rehm
Auckland was not always unaffordable. At the 1966 Census the $9,900 average Auckland home price was just under three times the average household income. A price-to-income ratio of three generally represents the upper threshold of housing affordability. However, in June 2018 the median home price stood at $850,000, more than eight times the median household income. Housing markets with price to-income ratios exceeding five are considered ‘severely unaffordable’
It is common for home ownership to come at a cost premium to renting. In 1966, the weekly mortgage payment for the average house price was 34 percent higher than the rent paid for the same home. However in 2018 this premium had risen to 112 percent despite similar interest rates. A key reason is the financialisation of housing. The family home now serves a dual purpose as shelter and investment. The home has been
redefined as an object of speculation.
While housing speculation is somewhat veiled in the owner-occupant housing submarket, it is obvious with rental property. An unpublished analysis of 2016 leveraged rental home purchases in Auckland found that 80 percent are ‘negatively geared’ and operate at a loss. The remaining 20 percent are estimated to generate positive cash flows but rental yields fall below prevailing term deposit rates. Effectively these ‘investments’ cannot stand on their own merits and are predicated on future capital gains to justify the purchase.
The Auckland housing market is caught in a cycle of speculation and has become a casino. Investors bet squarely on capital gains. As investors represent a substantial share of home purchasers in Auckland, an effective antispeculation housing policy targeted at this group will likely go a long way to winding down the casino and re-establishing housing affordability. Policymakers have recently ring-fenced rental property losses thereby cutting off hundreds of millions worth of annual tax rebates to negatively geared investors. This will help but it does not go far enough. Unfortunately, the government rejected the Tax Working Group’s cornerstone recommendation for a comprehensive capital gains tax.
There is, however, a long-standing, but unused, statute that is arguably a more just and effective anti-speculation policy tool than the abandoned capital gains tax. The Income Tax Act’s ‘intention test’ is laid out in section CB6 and deals with the acquisition of property for the purpose of making profit through resale. The IRD and Treasury have formally admitted that speculating property investors are gaming the tax system and are opting not to report profits from resale despite capital gains being a genuine motive to purchase. Our analysis developed a novel, evidence-based approach to operationalise the intention test and enable the IRD to enforce the existing law.
Aside from investors, lenders also actively speculate in the housing market. Finance professionals are aware when approving new investment mortgages that these rental properties are incapable of generating adequate rental yields and that many assets they lend on operate at a loss. According to the Reserve Bank only eight percent of households own investment properties but they account for 40 percent of housing debt. This small minority of households forms a disproportionate share of banks’ business and their profits.
Accentuating their own speculative behaviour, lenders have shown an acute eagerness to extend interest-only mortgages on these so-called investments. Interest-only loans account for more than half of new lending on rental property. These loan types are risky and are associated with housing speculation. When the whirlpool of speculation was forming, lenders served as willing accomplices.
So contrary to views expressed by politicians and pundits, the main driving force behind unaffordable housing is not a mismatch between housing supply and the need for shelter but the financialisation of housing. In particular, lenders’ willingness to extend increasing amounts of mortgage debt in proportion to borrower income has facilitated Auckland’s severely unaffordable house prices.
If society desires affordable housing it must implore its political representatives to enforce the existing anti-speculation ‘intention test’. Furthermore the government should be urged to support the Reserve Bank Governor as he undertakes a more intensive and intrusive regulatory approach including heightened capital ratios and a debt-to-income limit tool.
The path to affordable housing will be particularly unpopular and painful for some but a controlled descent is better than a crash landing.
Michael Rehm is a Senior Lecturer in Property at the University of Auckland. He is an expert in sustainable real estate development.