Prospect of tax changes makes buyers think twice
Investors will be hit hard if Commission on Taxation proposals for housing are applied, writes Brian Devine
The global economy, which earlier in the year had looked like it was turning in on itself, is now beginning to grow once again; Ireland, although lagging, will also begin to grow some time over the coming year. So far, so good.
Unfortunately, Ireland has a structural problem when it comes to the public finances. In other words, the resumption of global and domestic growth will not be sufficient to close the gap between Government revenue and Government spending.
The measures already undertaken this year -- income levies, pension levy, capital expenditure cuts, etc -- only go part of the way in addressing the structural problems underlying the Irish public finances.
The Government is aiming to cut a further €16.35bn, or 9.5 per cent of GDP, from the deficit over the years 2010-2013 via a mixture of tax hikes and expenditure cuts. If this is done, Ireland's Government deficit will reach the magical three per cent of GDP, according to the Government, by 2013 (I am more sceptical on the trajectory of the deficit). After all those adjustments, the Government would still be borrowing €9.4bn in 2013.
Being in breach of the Maastricht criteria, a Government deficit in excess of 3 per cent is not the concern. Rather it is the extra Government debt that we are accumulating along the way, and the associated interest payments, that are the concern. Thus it is clear that more taxes and expenditure cuts are required.
In relation to the residential property sector, the Commission on Taxation has recommended that: stamp duty for purchasers of principal private residences be abolished; stamp duty should continue to apply to investor purchasers of residential housing units; an annual property tax be levied on all residential housing units, with some exceptions; and mortgage tax relief for non-first time buyers be abolished.
It is ultimately the Government's decision whether or not to implement these recommendations. Media reports suggest that they are unlikely to be a part of Budget 2010.
Whether or not they are implemented, the release of the recommendations has likely severely impacted activity in the secondhand, second-time purchaser market for the rest of the year. Why would one purchase a second-hand property today if the possibility exists that you wouldn't have to pay stamp duty next year? The average second-time purchaser house price is €276,000, according to the latest Permanent TSB/Economic and Social Research Institute house price index. The stamp duty on such a property would be approximately €10,500 -- not an inconsequential amount of money.
It is sloppy that the Government has allowed such a situation to develop, especially given that the UK saw a drop-off in transactions following a similar revelation last year.
Now, moving to the land of conjecture. If the property recommendations are implemented, the tax burden on first-time buyers will be increased as they were exempt from paying stamp duty anyway. This will clearly have some impact on demand from this segment, but if house prices are attractive relative to renting then it should not be a major obstacle.
The removal of stamp duty would likely breathe some life into the property market at the margin by increasing the likelihood of existing property owners who were thinking of downgrading/relocating to actually do so.
The word "upgrade" was purposely left-out of the preceding sentence as the removal of mortgage interest relief would be a counterbalancing factor for households considering upgrading.
The most severely affected market, though, would be the investor market. Investors will still be subject to stamp duty on purchases, while also having to fork out the annual property tax. Demand by residential investors has hardly been burgeoning, given that rents have been falling nearly as quickly as house prices, but they are an important component of determining the supply/demand balance in the property market.
I like to compare the number of first-time buyer and residential investor mortgage drawdowns to properties available for sale. There are almost 62,000 properties available for sale on Daft. Of course, there needs to be a base level of housing stock available for sale. A sustainable medium-term level of stock available for sale would be about 26,000 properties, implying an excess of 36,000 on the sales market.
First-time buyer and residential investor drawdowns were running at a monthly rate of 1,350 in the period April-June. At this rate, it would take 26 months to clear the excess .
Now let's assume that mortgage drawdowns are running at their 2008 monthly levels of 1,660 for first-time buyers and 1,100 for residential investors. In this scenario, it would take 13 months to clear the excess stock.
A possible scenario is that residential investor drawdowns stay at their current monthly level of 291. Even if first-time buyer drawdowns were to reach their 2008 levels, it would still take 18 months to clear the market due to the absence of residential investors. This example illustrates that if the residential investor is forced by taxation to become a bit-part player in the residential market, we will be dependent on first-time buyer activity to help clear the backlog of properties. The Commission's recommendations could stall the process of clearing the excess supply in the market.
Going back to the broader picture, the size of the required adjustment is often lost in the squabbling, lobbying and personal hardships that surround policy suggestions. Pointing out the flaws of one set of recommendations only means that a new set has to be formulated, which will impact on another sector.
The harsh reality is that every sector of Irish society will have further hits to take to curb Government borrowing. The severity of those hits will depend on the distribution of tax hikes/expenditure cuts chosen.
Brian Devine is an economist with NCB
