Book Extract: Generation Rent - Rethinking New Zealand's Priorities

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House prices may boom or bust but the long-term trend is clear: for more New Zealanders than ever, home ownership is out of reach. Incomes simply have not kept pace with skyrocketing property prices. ‘Generation Rent’ calls into question priorities at the heart of New Zealand’s identity.

In this BWB Text, Shamubeel and Selena Eaqub investigate how we ended up here, and what can be done to ensure all New Zealanders – home owners and renters alike – live in affordable and secure housing.

Extracted from Generation Rent Rethinking New Zealand’s Priorities by Shamubeel Eaqub and Selena Eaqub; Bridget Williams Books. Available to purchase here

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Chapter 4. What Needs To Change?

Unaffordable housing is not a problem unique to New Zealand, nor is it new – the problems have been brewing for decades. And many of the solutions listed below have been proposed for an equally long time and widely discussed.

Despite this acknowledgement of the issues, the solutions have either not been implemented or not been implemented well – here and abroad. The UK, Australia and Canada, the countries we often look to for policy direction, have all had successive property booms that have led to severely unaffordable housing. In the UK the situation is so bad that it is described as a ‘tale of disaster’ and there are repeated calls to improve housing supply, tidy up rules around lending, reform taxes on housing and improve rental conditions. The frustrations experienced in New Zealand are, clearly, mirrored in other places.

New Zealand and many of the other countries with severely unaffordable housing have also faced the challenges of slow housing supply in the past, notably in the post-war period. Back then, the government response was highly interventionist. The state, either directly or through local authorities, built a great many houses. It also created housing assistance programmes to help more people into home ownership.

Such an interventionist approach is no longer consistent with the dominant political thinking that an economy should be based on incentives, competitive forces and a well-functioning market. This is a deep-seated belief, and the ideology has become theology. The response to a housing crisis is to insist that we must just get the incentives right and the market will respond. But, even if this is the case, it will take a long time for this approach to work – as we have seen from the last two and a half decades of slow house building. We also know from history that direct intervention, by building a large supply of new housing on under developed land or by increasing social housing, would meet many needs. But such intervention would not be a lasting solution as we still need the broader market to be responsive. Otherwise, the problems we have now will simply repeat in future.

In New Zealand, as elsewhere, the ultimate difficulty in tackling the housing market lies in finding the political consensus and the necessary persistence to push through changes that may adversely affect current property owners (including those with significant political influence), in favour of a more equitable situation for future generations (who do not yet vote and have little representation). Abraham Lincoln summed up this task in 1858 thus:

In this and like communities, public sentiment is everything. With public sentiment, nothing can fail; without it, nothing can succeed.

If we are to solve New Zealand’s housing crisis, the public must be united in its understanding of the issues, the outcomes being sought, and the policies that will be needed to bring about a solution.

Without a shared vision and common purpose, fractured politics will lead us down a path that pits one generation against another. We need to have a mature conversation about what values we favour, what we plan to do and how we will stick to that plan, because the solutions will take a generation to implement. They will also be complex, because they have to increase housing affordability over time, acknowledging that home ownership is important to New Zealanders, while simultaneously improving rental conditions for those who choose to or are forced to rent long term.

To expect an easy and quick solution is delusional. Sadly, much of the public debate centres on one quick fix, such as banning foreign investment or limiting immigration. Equally, however, to despair of the task, to argue that it is too hard and that we can do nothing, is a road to ruin.

To expect our political leaders to do the right thing is of course ambitious. Since the 1990s, successive governments of various political leanings have presided over a long erosion of housing affordability. Courageous leadership on housing is clearly needed, but remains absent. Politicians at once want to increase house prices in order to satisfy home owners, and lower them in order to please renters wishing to buy. (The average member of Parliament owns at least two homes. As a result, current housing policies tend to favour home owners and rental investors. Banks are also a powerful lobby group and, as institutions that invest heavily in mortgages, their main aim is to see house prices rise. Several banking chief executives have publicly denied that there is a housing bubble at all. Young people, many of whom have disengaged from parliamentary democracy (in the 2014 election, just over half of non-voters were aged under forty, lack a strong voice in political discourse and are disadvantaged by New Zealand’s housing policies. The interests of future generations, those not yet born or too young to vote, are arguably not represented at all. So if we are to expect leadership on housing, those New Zealanders who are engaged will have to understand the issues better and use their political power. Renters now make up more than half the country: that is a powerful constituency for change. Our aim in this book is to inform that growing desire for change with our understanding of the issues, consequences and solutions.

Since our housing problems have been caused by many different factors, accumulating over time, they cannot be fixed by a single policy change. There will not be ‘one solution to rule them all’. The first set of solutions – palliative in their nature – will be to provide better and more sustainable living conditions for Generation Rent. The second set will take the heat out of the housing market in the current cycle, by using levers to control demand: raising interest rates, reducing credit availability, creating a more responsive construction sector and perhaps restricting migration and limiting foreign buying. But these cyclical measures, though useful, will only buy us time. Throughout the cyclical ups and downs, prices have steadily trended upwards because of underlying policy errors. The real fixes, and the hard work, will be in correcting structural problems: slow land supply; expensive infrastructure provision and a broken model for its funding; taxes that favour housing; and policies that encourage banks to lend more for individual property investment.

Below, we offer ten ideas that could improve the housing situation – changes that we, as citizens of New Zealand, demand from our politicians. We have space here only for sketches of the policies. But these should still help the reader think through the policy options and the results they could have. Implementing these proposals in ones and twos, however, will not help. They need to be delivered as a package – only then can we begin to relieve the accumulated pressures of the broken policies of many decades.

Our policy ideas can be summarised as follows:

Palliative care

1) Fix the rental market and change attitudes towards renting and property investments

2) Build more houses

Short-term cyclical solutions

3) Use monetary and macro-prudential policy to rein in the market

4) Clarify immigration policy

5) Improve data collection to identify the impact of foreign buyers, and act on this issue if they are proven to be fuelling housing unaffordability

The real deal: structural solutions

6) Increase the supply of housing in high-demand areas, be open to changes, deal with Nimbys and create sustainable funding arrangements for infrastructure

7) Reduce the easy supply of money for housing by reforming banking regulation

8) Clarify the existing tax rules on property investment and have an open discussion on negative gearing and ring-fencing income from investment properties, and imputed rent

9) Improve financial markets and financial literacy to provide an alternative to investing in property

10) Improve the scale, productivity and resilience of the construction sector to make building companies more responsive to changes in economic conditions.

SOLUTION 1: FIX THE RENTAL MARKET

One way we can improve the quality of life for renters is by fixing rental rules. More people than ever are renting, yet New Zealand has one of the weakest tenant protection systems in the world, on a par with the UK and Australia. Fixing this will make life better both for people who have effectively been ‘forced’ into renting and for those who want to be renting. Doing so would also lessen the pressure on young people to buy a home, and therefore reduce some of the demand for home ownership that pushes up house prices.

The first thing that New Zealand needs is more rental properties with longer-term leases. Leases currently tend to be short term, with more than half of tenancies lasting only ten months. In comparison, owner-occupiers spend an average of seven years in their home. Short-term leases can make tenants feel insecure in their rental properties and, ultimately, make it difficult for them to feel at ‘home’.

In New Zealand, rental agreements can be either periodic or fixed-term agreements, with periodic the most common. With a periodic lease, a landlord can give ninety days’ notice to remove a tenant from the premises, but this can be shortened to forty-two days if the landlord sells the house or needs it for the use of a family member or an employee. Since housing in New Zealand is an investor’s market, tenants are often in rental properties from which they could be evicted at short notice because the landlord has decided that now is the right time to sell.

On the other side of the ledger, if tenants want to move out, they only have to provide twenty-one days’ notice under a periodic lease agreement. This does not leave much time for landlords to fill the vacant property.

In addition, the New Zealand rental sector lacks leniency towards alterations and pets. These are things that are important to people and can help change a house into a ‘home’. But having pets in the house and making minor alterations, like painting a wall or changing the carpet, both generally need consent from the landlord. By contrast, in many European countries alterations are expected, much as they are in the New Zealand commercial property market. In these kinds of contracts, you are effectively renting the shell of the place and what you do with the interior is up to you. When you leave, you are usually asked to put it back the way you found it.

New Zealand’s tenancy laws may have been suitable when they were first made, when renters were mainly young people who did not require as much security of tenure. Today, however, it is increasingly common for older people and families with children to rent. Families with children need longer term security for schooling purposes, while older people need stability because they are less mobile and it is harder for them to move their belongings physically. Young people without children may also value longer term security.

As well as tenure length, we have to look at the quality of rental housing. Just like owner-occupied housing, much rental housing is of poor quality. However, the rental housing stock also tends to be older than the owner-occupied stock. New Zealand Herald columnist Lee Suckling’s experience is all too common:

At every viewing you’ll be one of at least 20 people. You’ll wait patiently outside, eyeing up the competition, then will line up like sheep, shoes off, ready to file in five-at-a-time. The reality is never as good as what TradeMe presents ... If you’re looking in a city-fringe suburb, you will be met with grottiness. Auckland landlords, you seriously need to have your houses professionally cleaned. Last time we checked, $500 a week didn’t buy us mould.7

While some landlords are experienced, many are amateurs. Few are large-scale landlords or institutions managing many properties. In contrast, in countries such as Germany, there are many institutions involved in managing property, which lifts the overall quality of property management. Many landlords in New Zealand are in the business solely for the capital gains, and maintenance of properties is therefore beyond their experience and their interest.

For landlord-tenant relationships to succeed, there need to be rules clearly defining what is required from both parties when it comes to the operational, day-to-day aspects of renting. This includes the expectations of both parties – for example, what state the rental property should be in, how quickly and what type of repairs should be done, or what state the tenant should leave the property in when they vacate it.

What landlords want

Landlords invest in property to get returns on their investment, both from capital gains and from rental yields. For many landlords, rental property is a business investment and a major source of retirement savings.

Many landlords prefer long-term tenancies because these provide a guaranteed income from rent. Landlords lose out when properties are vacant between tenancies because they still have to cover costs such as the mortgage, maintenance, insurance and rates, but they are getting no income to pay for these. Periodic tenancies contain the risk that a tenant may leave suddenly and the landlord will have to find another one very quickly. As noted above, tenants only have to give twenty-one days’ notice that they intend to leave.

At the same time, landlords would like to spend less time managing tenants. Some landlords struggle with tracing tenants to recover rent left unpaid after their departure from a property. Landlords also say it is difficult to judge the character of a tenant, and they cannot access information they would like to have, such as whether a potential tenant has paid their rent on time in previous properties. There also needs to be adequate protection of landlords’ property. International evidence suggests that homes depreciate by 1.5 per cent more per year if they are inhabited by renters rather than by owners (who work harder to take care of their most important asset).

A balance needs to be found to meet the needs of both tenants and landlords, to make room for more households with security of tenure. While short-term leases are still necessary and appropriate for some members of the public, there needs to be greater availability of long-term leases. Among the many benefits for both landlords and tenants of long-term tenancies is the fact that tenants get to feel settled in their house. Landlords also get secure income and tenants who treat their property with care because they feel like the property is their home. With a lower turnover of tenants, there is also less damage to the property, because furniture is not moved in and out so often.

Germany and Switzerland set a good example for rental markets

New Zealand can learn from Germany and Switzerland when it comes to levelling the playing field between renting and owning. As shown in Figure 4.1, house prices in those two countries have not increased as they have in New Zealand or Ireland – rather, they have only just kept pace with the cost of living. Houses in Germany and Switzerland are a hedge against inflation but not a speculative wealth generator. In Germany most people rent: at 57 per cent, the country’s rental rate is the second highest in Europe (with 90 per cent renting in Berlin). There a re several reasons why this rate is so high. On the supply side, there is a good stock of high-quality rental accommodation that is of no lesser quality than owner-occupied housing. Rental properties are provided by both amateur landlords and institutions, with the former owning 60 per cent of rented housing units. Amateur landlords can vary in experience, but having institutions in the mix at least means there are some very experienced managers of residential properties able to fix major issues.

(Click to zoom)

In New Zealand, most amateur investors are motivated by capital gains, rather than the income from rents. Around 41 per cent of landlords in New Zealand are accidental landlords who do not even know what features tenants may be looking for. They differ from professional landlords and institutional investors, who buy future rental income and hold on to properties for a long period – and are more focused on tenants’ needs.

On the demand side, renting in Germany is socially acceptable and not seen as inferior to owning a house. Germany has a strong history of renting dating back to its nineteenth-century period of industrialisation. At that time, large stocks of rental houses were built for industry workers, located close to their workplaces so they could minimise their commute between home and work. Even after losing housing stock during the Second World War, the Government prioritised rental properties in its rebuild.

Another reason for Germany’s high proportion of renters is that access to finance to buy a home is not as easy as it is in New Zealand. German banks have stringent lending requirements. For mortgage lending, either a 20 per cent deposit or substantial collateral is normally required. The banks also need firm proof of earnings from a multiyear period.

Strong tenancy laws in Germany

Germany has tenancy agreements that give tenants greater protection in comparison to New Zealand. German laws are more favourable to tenants and make it easier for single people and families alike to settle into a rental property for the longer term, without the fear of being kicked out at short notice.

The most common type of agreement in Germany is a tenancy of an unlimited length. Landlords must give between three and nine months’ notice to evict a tenant, and can only do so with good reason. The amount of notice needed increases the longer the tenant has lived in the property. Three months is the minimum for someone who has lived in the property for less than five years; six months is required for a tenancy of five to eight years; and nine months’ notice is needed for those who have lived in the property more than eight years.

Landlords must also have a very good reason to evict a tenant – for example, if they need the premises for their own or their family’s use, or if the lease contract prevents them from making fully economical use of the premises. If a landlord is going to suffer severe financial difficulties, for instance when a building is damaged beyond repair and needs to be torn down, an eviction would be accepted. In contrast, a desire to obtain a higher rent for the property or a simple decision to sell it do not constitute good reasons for eviction.German laws do not enable property speculation in the same way as New Zealand laws, which, as discussed above, allow landlords to evict tenants quickly if they want to sell. German rental investors must abide by stringent rules and cannot remove tenants quickly in order to take advantage of higher house prices. It is for these reasons that German house prices have barely kept pace with general prices since 1990.

German laws on alterations and pets are also much more relaxed. Pets are allowed and minor alterations are permitted and considered normal. When renting in Germany, tenants are essentially paying for the shell of the building; even light fittings are not necessarily provided. People moving into a German flat generally find that the interior walls have been freshly painted in white by the previous tenants, so as to give them a blank canvas, and generally they themselves must repaint in white when it is their turn to vacate the flat.

Long-term tenancies need strong laws on rent increases to provide security to tenants. For this reason, rent increases are restricted in Germany. If a landlord tries to increase rents by more than 20 per cent over three years, he or she will be fined.

In Switzerland, meanwhile, the majority of households live in rented apartments or houses. In 2010, the home-ownership rate was just 37 per cent. Unlike in Germany, renting is often not by choice; more commonly it is due to house prices being very high relative to household income and wealth. This is in part because supply is constrained by Switzerland’s topography.

As a result, housing conditions in Switzerland favour renters. Owner-occupied dwellings are heavily taxed, making owning less attractive. Renting is supported by the government: in some cantons (districts), rent payments can be partially deducted from income for the purposes of income taxes, and a small percentage of renters benefit from subsidies. In terms of the quality of the property, rental and owner-occupied housing rates about the same.

Swiss laws also contain strong protections for renters. Leases are either indefinite or periodic. Landlords must give between three and six months’ notice and have good grounds for evicting a tenant. Terminations of a lease are possible if the landlord has a serious motive and does not violate good faith. For example, evictions in ‘revenge’ for a complaint made by a tenant would not be allowed. If the landlord is simply looking to exercise their right over the property or is claiming changed family circumstances, the eviction can be contested by the tenant. Pet ownership is common and so are alterations. People wanting to make alterations, however, generally ask the landlord first, because they may be asked to restore the property to its original state when they leave.

Lessons for New Zealand

New Zealand’s typically short-term leases for rental properties, combined with other conditions discriminating against renters, do not make renting an adequate alternative to home ownership. And changing this situation will not be easy. People are often affected by ‘status quo bias’, a fancy name for inertia, which causes them to accept the status quo or default option, even if they do not actually have a strong preference for it. We see this whenever we are presented with options for car features or cell phone settings, for instance – most people will simply go with whatever is the standard or default option.

This implies that one of the best ways to move towards more long-term leases would be to change the default option. This technique is already used in KiwiSaver, for example, where people are automatically enrolled in an investment scheme and have to actively opt out if they do not want to be in one. The technique is known in policy circles as ‘nudging’, because it encourages people towards a certain option that policy-makers have decided is desirable, but still allows them the freedom to choose other options if they really want to.

When it comes to tenancy laws, the government could change its template tenancy agreement to include a standard tenancy term of three years (for example). If a landlord or tenant wanted a different length of term, they would have to actively choose to deviate from the template. If introduced in this way, longer tenancies would probably become gradually accepted, and the average length of tenancies would increase over time. But it would preserve the current flexibility and the ability for tenants and landlords to sign short-term agreements if that is what suits them.

New Zealand also needs to reconsider its laws regarding notice periods for tenants and the reasons for eviction. The notice period of forty-two days simply provides too little security for tenants who want to settle in a particular area, raise a family or make their house a proper home. It should be made longer, following the lead of the German or Swiss model. Similarly, the law should be changed so that the standard tenancy agreement allows tenants to make alterations such as painting walls, hanging up pictures or changing the carpet. However, the law should also stipulate that, when leaving a property, tenants must return it to its original state unless their changes are accepted by the landlord. In combination, these changes would give tenants much greater ‘ownership’ of the property, despite not having equity in it, while preserving the landlord’s ultimate control of the asset.

Changing attitudes towards renting and investment property

Renting in New Zealand is often viewed as an inferior and short-term option, something done during student days before one can buy a home. Renters are sometimes stigmatised, having to deal with disbelief that they are ‘still renting’ and the widespread view that they are financially insecure or even wasteful. The majority of New Zealanders now live in rental properties. Renting is not a minority issue anymore. Yet people with vested interests in property, such as property organisations and banks, continue to reiterate the superiority of home ownership.

We have to remove the stigma from renting and make it a valid option for any household, as it is in Germany and Switzerland. Doing so requires us to confront our cultural belief that home owning is implicitly a requirement of ‘growing up’ and ‘making it’. The reality is that no matter what is done to improve housing affordability, the situation will not change overnight, and increasingly large numbers of people in the 30–50 age bracket are going to rent. We should be making it easier for families to be renters, and part of that involves thinking and talking about renting in a positive way, so that they no longer feel stigmatised.

Another benefit of de-stigmatising renting is that it would encourage more top-flight property managers into the rental property market. As noted above, Germany has a large number of institutions supplying rental housing, as well as private landlords. If more people were willing to rent long term, more of these types of companies would enter our market.

One of the prevailing myths about renters is that they must be financially insecure because they do not have investment in the form of a house. This belief stems from the fact that investing in housing is the main means of accruing savings in New Zealand. If you are not either a home owner or on the way to being one, in many people’s eyes you are not saving for retirement. The solution here is to reduce the dependence on housing as a form of investment. That will require changing the favourable tax treatment of housing and increasing the attractiveness of other investment options, ideas for which are set out below. It will also involve improving financial literacy. Another strongly held myth about renting is that when a person rents, they are ‘throwing their money away’ or paying someone else’s mortgage. This is simply untrue. Because house prices have risen so much in Auckland, rents are barely equal to the usual outgoings of rates, insurance, and maintenance – let alone mortgage payments. These combined costs amount on average to almost twice as much as the costs of renting. If a renter saves the difference between what mortgage payments would be and what they pay in rent, they are clearly saving, and can invest the difference in other areas.

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Shamubeel Eaqub is one of New Zealand's best-known commentators on economic issues, contrarian or otherwise, a regular media contributor and speaker at conferences and events.

His day job is as a macroeconomist and principal economist at the NZ Institute of Economic Research (NZIER), an independent economic consultancy. At NZIER, he forecasts the economy, provides macroeconomic advice to NZIER’s members, and works as a consultant. 

Now a Wellingtonian, he was born in Bangladesh  and immigrated to New Zealand with his family after three years in Samoa. He grew up in Lincoln, Canterbury and attended Lincoln High School and Lincoln University. He graduated with a bachelor of commerce with honours in economics. He is also a qualified chartered financial analyst.

He worked at Statistics New Zealand and ANZ Bank in Wellington and Melbourne after graduating from university and was later the New Zealand economist and financial analyst covering the property sector for Goldman Sachs JBWere.

Mr Eaqub is a member of the CFA Institute, the Institute of Directors and NZ Asian Leaders. He has co-authored a book, titled The New Zealand Economy: An Introduction aimed at high school students. His skills have helped him widen NZIER's market presence. For example, he recently helped a Middle East client establish an investment and broking firm in Sri Lanka. 

Copyright © 2015 Shamubeel Eaqub and and Selena Eaqub

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