Regulatory risk – and opportunity

Sonnie Bailey

12 February 2021

I was interested in this article on two days ago: “MPs from all sides turn on Treasury, Reserve Bank and Labour over failure to act on housing”.

It reminded me of the maxim: “You may not be interested in politics, but politics is interested in you”.

In the context of investing, it reminded me of a risk that many of us don’t pay enough attention to. Regulatory risk.

This doesn’t just relate to residential property, but it’s a good case study in the context of the Stuff article.

The New Zealand residential property market is an interesting creature, and I don’t hold myself out as an expert on the topic. But I will say this: the factors that influence property values (or at least, property prices) are multifactorial. Yes, it’s ultimately supply versus demand. But the factors that influence supply and demand are numerous and their interactions are complex.

Factors include local and national barriers to increasing supply and population growth.

Various policy settings are influential, as well. You can debate about the extent to which these settings impact the market, but it’s hard to argue whether they have an impact, at least for some buyers and sellers.

All else being equal, higher minimum obligations for landlords make owning a rental property more expensive, less profitable, and less attractive.

All else being equal, the bright-line property rule (meaning that properties sold within certain time frames are subject to income tax on gains) makes it less attractive to own a property for a short period of time.

The prospect of a broader capital gains tax also makes property less attractive. (Yes, Prime Minister Ardern has said we won’t see capital gains tax on her watch, but that doesn’t rule it out for all time.)

There are also policies elsewhere that make homeownership even more attractive and drive prices up. In the US, for example, some homeowners can deduct mortgage interest from their household taxable income. If KiwiSaver was opened up so that people could use their KiwiSaver funds to invest in direct residential property, this would increase demand and increase prices. (For the record: I am strongly against both of these policies. You’d struggle to find someone with a background in economics who’d support them.)

Broader policies cast a large shadow

There are other policy settings which have an impact as well, even if the effect is indirect. These include policies relating to pensions/superannuation, health, and education funding.

For instance, in New Zealand, we have a simple, universal superannuation scheme that provides retirees with a fair amount of certainty about their financial futures. We also have a public health system which provides for most needs. This is quite different to, say, the US where pension schemes are far more complex, and the cover provided by Medicare and Medicaid isn’t as extensive, necessitating extensive and expensive health insurance policies.

This combination of policies breeds a fair amount more financial certainty for older Kiwis – our poverty rate for people over the age of 65 is quite a bit lower than other developed nations, particularly the US.

Add to this, that parents in the US are often called upon to fund their children’s tertiary education, often to the tune of tens, if not hundreds, of thousands of dollars.

The above combination of policy settings in the US means that it is less common for “the bank of mum and dad” to help with children buying properties. This greater band of uncertainty and household costs also means that most households have less discretionary income with which to compete in property prices.

These are factors (but not determinants) for why the median house price in the US is around NZD395,000 whereas the median property price in New Zealand is NZD749,000 (specifically, the US median is USD285,000 based on the May 2020 figure from the National Association of REALTORS; the NZ figure is based on the REINZ Residential Statistics Report for December 2020).

(Regarding the US, we often read about what is happening in New York in San Francisco, but those housing markets are outliers with high concentrations of wealth; in 2003 Mayor Bloomberg referred to New York City as “a luxury product”, an assessment that was fairly prescient, whatever your thoughts/feelings on the matter are.)

Regulatory opportunities (arbitrage)

Of course, I’ve focused on the risk side of the regulatory equation. There are also regulatory opportunities for people who pay attention to this.

I’ve mentioned policies that could drive up demand and increase prices further: opening up KiwiSaver to invest in direct residential property or making mortgage payments tax-deductible.

There are also NIMBY-style regulations limiting property development (hindering supply from keeping up with demand).

Policy can create investment risk. It can also create opportunity.

A random aside about property prices

I always scratch my head when I read articles about forecasts like “five years of price growth, outstripping wage growth”.

In an “efficient” market, prices for assets reflect expectations about the future. So if there’s a consensus view that property prices will continue to rise for 5 years, this creates super-profit opportunities for earlier investors, so it makes sense that people inclined to invest would do so immediately, to take advantage of the subsequent price growth.

If the market were “efficient”, this would immediately result in increased demand, which would increase prices, to an equilibrium point where these expectations about price increases end up being built into the market – meaning that growth would be concentrated over a short period of time, in which case price growth wouldn’t continue over the projected period of time.

Maybe that’s what has been happening in the past few months, and people will be surprised when property prices don’t continue to grow at the same rate. Who knows. I don’t have a crystal ball.


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