Residential property market: what lies ahead

The first four years of this decade have seen some big swings in residential property prices. Let’s cast our minds back to the start of this decade where, on the back of low interest rates, strong employment and supportive fiscal policy, house prices across New Zealand rose sharply. As a consequence, housing affordability (as measured by debt to income), worsened in the two years after the COVID pandemic.

House prices relative to incomes reached new highs in 2021/2022 and remain elevated compared to the last decade. It was a particularly difficult market for first home buyers, who not only had to save a larger deposit, but also faced a much higher debt-servicing cost as a share of income compared to the preceding decade.

House prices were not the only costs to rise. In 2022, as inflation became entrenched globally, many central banks increased interest rates in an attempt to bring inflation down. With housing affordability already stretched, high interest rates on top of broader cost of living pressures, put the housing market in a tight spot and it has continued to weaken over 2023-2024. Subdued sales and a rising number of listings on the market suggest weakness is likely to persist in the near term.

There are, however, some clear tailwinds. Population growth (positive net migration), the restoration of the interest deductibility for rental property and falling interest rates all have the potential to contribute to a recovery in demand, In addition, a reduction in the bright-line period, and revisions to the bright-line rule exemptions (which could be of benefit for parents/grandparents seeking to assist younger family generations into their own homes) could also be supportive.

Please refer to the information at the end of this article which summarises the changes to the bright-line test and interest deductibility.

Confident that inflation is tracking toward its 1-3% target band, the Reserve Bank of New Zealand started its Official Cash Rate easing cycle in August, and set expectations that it will continue to steadily cut interest rates through 2025 if inflation continues to trend in the right direction. Mortgage rates have already responded and are expected to decline in line with falling central bank interest rates.

Mortgage rates are an important driver of the housing market but aren’t the only influence on prices and sale volumes. While a broader recovery in the property market is expected in 2025, as economic tailwinds and headwinds continue to play out, prices have the potential to correct further before demand and supply find a new equilibrium.

Below you’ll find information which summarises the changes to the bright-line test and tax deductibility.

The bright-line test (or bright-line rule) means if you sell a residential investment property within a set time after purchasing it, you may have to pay income tax if you make a gain on the sale. There are some exceptions to this rule, such as:

• The property is your main home
• Rollover relief applies, e.g. the property is transferred under a relationship property agreement. 

Until 30 June 2024, New Zealand’s bright-line test applied to properties that were purchased on or after 27 March 2021 and sold within five years (for qualifying new builds) or within 10 years (for all other properties). If you purchased your property between 29 March 2018 and 26 March 2021, and sell it within five years, it will fall under the current bright-line test too.

From 1 July 2024, the bright-line test returned to a two-year period. This means if you sell your rental property on or after 1 July 2024, you’ll be taxed on any gains you make from the sale if you’ve owned the property for two years or less.

The main home and rollover relief exclusions will still apply, but they’ll be tested slightly differently.

• Main home: Your property will be considered a ‘main home’ if most of the home was used for most of the time you owned the property. ‘Most’ in this case means more than 50% (this is called a ‘predominant use’ test).
• Rollover relief: Rollover relief is getting simpler. Now, if the property is transferred between ‘associated persons’ (for example, close relatives or the beneficiaries of a trust), the bright-line test won’t apply as long as those persons have been associated for at least two years before the transfer.

Read more about the bright-line test on IR’s website.

If you own a rental property with a mortgage, interest deductibility means you can deduct the interest you pay on that mortgage from the income you receive as rent when determining your taxable income.

In 2021, rules were put in place that meant:

• You could no longer claim a deduction for interest on your rental property if you purchased it on or after 27 March 2021 
• Your ability to claim interest deduction for rental property purchased before 27 March 2021 was being phased out.

There were some exceptions to this, such as if the property was a new-build.

Interest deductibility has been restored, which means you can now claim interest as an expense for any residential investment property you own, irrespective of when the rental property was purchased or when the loan was drawn down. The changes are happening in two phases:

• From 1 April 2024, you can claim a deduction for 80% of the interest on funds borrowed for the residential property 
• From 1 April 2025, you’ll be able to claim 100% of the interest deduction instead of 80%.

Tax calculations can be complex and affect investors differently. The savings from these tax changes may differ, as tax rules vary according to property type, date of purchase and who is renting the property.

Read more about property interest limitation rules on IR’s website.