As I gaze up at the beautiful 1906 heritage property a friend of mine owns in the centre of Wellington, it’s hard to believe all the problems it’s causing him. Although it’s 100’s of kilometres away from Christchurch, the effects of the 22 February 2011 earthquake have hit this property hard.

Around the country insurance rates have skyrocketed – most notably for earthquake prone buildings (EPBs) such as this one. The Building Act defines an EPB as a building that would be likely to collapse during a moderate earthquake causing injury, death or damage to another property and the Act delegates local authorities to adopt specific policy to address these buildings. Several years ago, the Wellington City  Council gave owners of EPBs in the region up to 20 years to complete the required strengthening. The 1906 heritage property is part of a body corporate and following the strengthening notification adequate budgeting was established to allow the required work to be performed in the next 15 years.

Since then, the impact of the Canterbury earthquakes has changed things dramatically. Tenants have becomes more savvy about selecting properties which are considered safe, values of EPBs have plunged and Councils have become more vigilant. Wellington City Council expressed a desire to review current policy and extend its role beyond regulatory functions. Gisborne District Council proposed a major change in the time period  allowed for the completion of strengthening work – from 25 to10 years. Even Auckland City Council, in a city of comparatively low seismic activity, responded by proposing active implementation of policies surrounding strengthening work.

Insurance companies have matched their concern. It wasn’t just the rise in premiums – many insurance companies have decided insuring EPBs simply isn’t worth the risk. Only one insurer in New Zealand agreed to insure the Wellington property in question, but that came at a cost - an annual increase in the premiums of more than 1200%. Now, my friend and the other owners are haemorrhaging money every month just to cover the insurance premiums. Suddenly the strengthening work due to be completed in 15 years has become a priority, if nothing more than to bring the insurance premium down.

Property owners are essentially backed against the wall. The cost to complete the earthquake strengthening is significant, but if they don’t do it, the ongoing insurance costs make owning the property grossly uneconomic. This is a nationwide problem. A report to the Royal Commission after the Christchurch earthquake estimated that there were almost 4,000 unreinforced masonry buildings around New Zealand and that getting them up to code will cost around $2 billion. To add insult to injury, any costs incurred in the requisite strengthening work will be considered capital expenditure from a tax perspective and non-deductible (for those owners that use the property to generate income). Well established case law has considered this issue in depth. With the recent removal of depreciation on buildings – any costs incurred by landlords and business owners will represent ‘blackhole’ expenditure.

This Budget presents the perfect opportunity for the Government to introduce tax based policies to incentivise property owners to carry out earthquake strengthening work on their properties sooner rather than later. Using tax incentives to alter behaviour is not a new concept, and if adequately structured it can produce positive outcomes for the wider economy. For example, a tax rebate could be offered on every dollar spent on qualifying strengthening work performed within a prescribed timeframe (say a five year window). Such an incentive would undoubtedly accelerate property owners’ decision making processes, while increasing  building activity over the incentive period.

The reality is the $2 billion spend required to get these properties up to standard would stimulate the New Zealand economy over the incentive period – something that is desperately needed. Many industries have been relying on the Christchurch rebuild, which still isn’t happening yet and may not start for another few years. If there were other projects to engage construction workers, engineers and other experts, this would generate growth in the economy and keep those workers employed until the Christchurch rebuild is ready to begin.

It may be that amending the tax treatment of such costs on its own would not be enough to generate the desired acceleration on the required strengthening. Another area where property owners will no doubt be struggling is their ability to finance such significant expenditure. Wellington Council is considering ways  they can help property owners – through interest free loans, targeted rates and other measures. However, to be truly effective, help needs to come from Central Government. Policy officials need to consider how to offer financing assistance to effected property owners in a meaningful way to aid these strengthening works - perhaps an underwritten government funding line with a charge over the property for recoupment (such as a suspensory loan)?

It’s not just the economic cost that should be encouraging the Government to consider these measures – but also the social cost. Forty-two people died due to partial failings of unreinforced masonry buildings in the Christchurch earthquake. Waiting up to 15 years to strengthen New Zealand’s unreinforced masonry buildings only increases the likelihood of more lives being lost unnecessarily. The Government needs to pro-actively encourage property owners to strengthen their properties now so they are safe for people to reside and work in. Using the tax system to incentivise this behaviour in conjunction with providing realistic financing options will have this desired effect.

The Government has shown their willingness to assist with earthquake related costs. The purchase of AMI and the decision to offer a buyout option to those who fell within the red zone are both things the Government didn’t have to do – but they felt a social responsibility and decided to assist. Providing tax incentives and financing options would be another positive step in this direction.

In Budget 2012 the Government needs to address this issue by acknowledging the extent of the economic and social pressures this situation is placing on property owners. Ultimately, introducing tax incentives and suitable financing options to encourage building strengthening is going to cost the Government a lot less than cleaning up the social and economic mess caused by the thousands of unreinforced buildings if another  disaster was to occur.This national issue requires Government intervention now – if adequate policies are established, it could generate the stimulation our economy urgently needs.

Further enquiries, please contact:

Dan Lowe           
Tax, Associate
T +64 9 308 2531