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How Brexit Could Impact Australian Property Investors

Date: 30/06/2016

 

UK - EUThe shock decision of the people of Great Britain to leave the European Union (EU) threw financial markets into a tailspin last Friday. The Pound fell 11 percent, the German share market lost 7.2 percent, and the ASX 200 was down 4 percent.

Homebuyers seemed to shrug off the chaos, as the following day’s auction clearance rates remained strong. Melbourne held steady around 68 percent and Sydney’s demand surged even higher, with a clearance rate over 77 percent. The prevailing opinion seemed to be that Brexit was no big deal, at least Down Under.

Whether the UK’s withdrawal from the EU will have a significant impact on our property market is yet to be seen, but smart property investors will develop their own rational opinion, and set their course accordingly.

Here’s a run-down of the potentially good, the possibly bad and the definitely ugly.

The Optimistic View

Property pundits, especially those with some skin in the game, have been quick to insist that Brexit will have a positive impact on the Australian real estate market. The theory is that many investors consider our property market to be a safe haven, an asset class with a firm track record of weathering economic storms.

LJ Hooker’s head of real estate, Christopher Mourd, said, “There is going to be a number of positives for Australian property specifically.”

In reference to international investors, Mourd suggests, “…while you have that upheaval and lack of surety in the UK market, they are going to look for other opportunities.”

Pointing to local investors, Mourd continued, “I think there is going to be quite a few people speaking to their investment advisers about potentially moving across [from shares] to bricks and mortar.

REA Group’s Chief Economist, Nerida Conisbee, agrees. “Australia is going to be seen as increasingly safe, particularly compared to the volatile European environment… The share market is likely to also be volatile and, as a result, we may see a flight to property.”

Last weekend’s auction clearance rates support this opinion. Furthermore, the S&P 500 and ASX 200 remain 13 percent and 9 percent above their February lows, so we are far from anything resembling a global financial crisis.

The Pessimistic View

italyThe gloomier outlook is a little more complex and therefore not too commonly held. It points to the overall lack of health in the European banking system and the risk of an international credit crunch.

Brexit has already thrown Italy into a banking crisis, some calling it the first domino to fall. Italy has one of the weakest economies in the EU, and many of their publicly traded banks have lost as much as a third of their values since the UK referendum. That’s a massive hit to the lending power of banks in a nation that is already drowning in debt.

The economies of all the EU nations are intimately entwined, so the European Central Bank (ECB) is highly motivated to backstop contagion and prevent more dominoes from falling.

The answer has been to print more Euros to keep bond yields low. This helps deeply indebted European nations keep their borrowing costs low as they roll over expiring debts by selling new bonds.

Italy is now appealing to the EU for a bailout, lest people lose faith in their ability to repay debt and their bond yields spike. What Italian politicians effectively want is for European taxpayers to buy up all the bad debt on the faltering Italian banks’ books, thus making them more stable.

But German and French politicians will resist, as their taxpayers won’t want to rescue fiscally irresponsible Italy. They will push instead for private investors and depositors in these Italian banks to pay up. Remember Cyprus?

Then there’s Spain, Greece, and Portugal, which are all in similar situations and will at some point need help from their stronger European partners to stay afloat.

But the problem is not only political but also economic. These stronger partners may end up being not all that strong if global deflationary pressures lead to a European recession as some have forecasted.

Add to that the fact that Britain just lost its AAA credit rating, which means borrowing costs there will rise. UK companies, banks, and governments have a lot of debt coming due in the next twelve months that will need to be refinanced, likely at higher interest rates. It will take some time before we know just how well the UK economy will hold up under this pressure.

Another big unknown is how European politicians will respond to the UK’s process of leaving the EU. Great Britain will want to maintain free trade agreements, but Europe will need to make the Brits pay for their rebellion, or risk other nations leaving as well.

Unfortunately for the EU, they are too economically weak to make an example of the English. Even after the divorce is final, the two will remain economically tied. If they force the British economy off a cliff in retribution, all of Europe will likely follow.

Apart from a miracle, the EU’s days are numbered. If Europe goes down, the Brits who voted “leave” will likely receive the blame. But if the EU cannot survive without the UK, was it really all that powerful to begin with?

Who cares? What’s the impact on the Australian property market?

For the Aussie real estate market to remain stable, our banks must have capital available to lend to buyers in the form of mortgages. Otherwise, there are few buyers. That money comes from one of two places: customer deposits and borrowings from overseas banks.

Since low interest rates have made term deposits and savings accounts very unattractive, banks have less local money to work with. Banks have solved that problem in the overseas lending market. They borrow at a low interest rate from overseas, then lend out at a higher interest rate here at home.

As you might expect, a large chunk of that money comes from European banks, the very ones grappling with their own internal challenges brought to light by Brexit. If those banks falter, so will our property market.

My Opinion

mortgageI’ve long held that one of the primary reasons real estate is so expensive here in Australia is the availability of cheap credit. The RBA has been suppressing interest rates since the GFC, and now some say our cash rate could go as low as .75 percent. This would be very bullish for real estate.

As a champion of the free market, I hope they don’t go that low. But I expect the Federal Reserve in the US to use Brexit as an excuse to revert course and take interest rates back to zero, and perhaps even lower. The ECB and Japan are already in negative territory, so why not in the USA too?

As central banks all over the world maintain their easing bias, our dollar gets stronger, which hurts our exporters and restricts our economic growth. In response, the RBA has little choice but to keep lowering interest rates.

The alternative is to let the free market determine interest rates, which means they would go higher. This would cause our debt-addicted economy to grind to a halt and would be political suicide for whoever is running our country at that time.

Unfortunately, sometimes the best choice is not politically expedient. Most politicians would rather kick the can down the road and force our grandchildren to pay the price. But we can’t blame them. We’re the ones keeping them in power.

So I expect interest rates to stay low for as long as possible. Lower interest rates usually mean higher asset values, so as long as banks can continue to access overseas money, property values will remain buoyant. If however the ECB loses control, which is a bigger risk than most people realise, it may be a different story.

As for Brexit leading to more investment in Australian real estate, I’m inclined to disagree. We’re already seeing Australian investors take advantage of the cheap Pound and transferring money to the UK in hopes of scoring property deals there. If that’s happening at home, why wouldn’t international investors also be anticipating bargains in Britain?

Assuming I’m wrong and investment in Aussie real estate ramps up, I can’t see property values going much higher. None of our politicians want property values to collapse, but they also don’t want homes to get more expensive. They are already facing backlash from disgruntled first homebuyers.

If interest rates keep going lower, I expect APRA to step in to increase capital requirements and slow down credit growth. Our regulators and politicians are highly motivated to keep property values relatively stable.

I believe their long-term hope is to solve the unaffordability issue through inflation, by devaluing our currency. If home prices remain stable and buying power decreases, wages should go up. If the median household income increases to $200,000 per annum, a $1 million home will not seem all that expensive.

Only time will tell if they can pull it off.

What do you think?

What’s your opinion on how Brexit will impact our property market? Share your thoughts in the comment section below.

Profile photo of Jason Staggers

By Jason Staggers

Jason was a personal mentor working with Steve McKnight's Property Apprentices. He helped hundreds of investors apply Steve's teachings in the real world and achieve greater results on their journey to financial freedom. Jason now lives in Perth, WA where he leads Neuma Church.

Comments

  1. Kris davant

    We are on the same page – we must listen to the likes of Ron Paul and Peter schiff. If you have not please do. They are pro free market and pro get rid of the central banks

  2. David

    Great article, I agree with most of what was said.

    The most obvious result will be all central banks lowering interest rates and kicking the can down the road, seems to be the way things will play out based on recent experience. I believe Mr Carney has already come out to calm investor nerves with words to the effect of, “Don’t worry! I have 250m GBP to throw at the problem should that be necessary.” I can’t say that it calms my nerves.

    I think the public will lose faith in central banks and start to realise they don’t know what they’re doing (if that isn’t happening already). Sure, Australia will most likely resume the long slow march to 0% interest rates and inflate asset prices for the next few years. But what is the end game? When everyone is at 0% there is nowhere to go besides throwing more money at the problem to paper over the cracks, and recent history has shown that this doesn’t work very well.

    The main result of QE is capital continues to be deployed inefficiently, and poorly performing businesses continue to be propped up when they should be allowed to die and be replaced by better peforming businesses (aka Schumpeter’s Gale).

    We are at the beginning of the end of this period of capitalism in my opinion. But, at the risk of sounding pompous, I will quote Kaletsky who said in Capitalism 4.0 that “capitalism bends, it doesn’t break”. Human instinct will kick in and people will find opportunities and find ways to make money again.

    Regardless, Australian property should prove to be an excellent store of wealth in the coming decades provided that the strong immigration and population growth continues.

    • Profile photo of Jason Staggers

      Thanks for your insights David. Great points, especially related to QE leading to malinvestment. I agree that recessions are healthy and necessary. I think one of our problems is we haven’t been allowed to have one in 25 years. My concern is the longer we delay, the greater the pain.

  3. Profile photo of DeanCollins

    I agree that kicking the can down the road is the worse thing politicians can do…..including the RBA eg I don’t think they should reduce below 1.75% because if they do they are just mortgaging future Australians ability to purchase a home to live in or investment property yields to invest in.

    I’m actually really starting to worry that in 5-10 years time Australia is going to have great economic hardship paying back to the property debt they have hobbled themselves with. eg I’ll be fine personally…..but think the economy will start to drag as people find themselves with less money to spend at restaurants/going to the movies etc when in 2018=2019 rates start to go back up.

    • Profile photo of Jason Staggers

      Great point Dean. I think the catch 22 is that this is one of the reasons why the government and RBA can not afford for asset values to come down and interest rates to go up. It could/will financially ruin many people.

      It seems we’re stuck in this perpetual low interest rate environment for now. Monetary easing offers diminishing returns, so what happens when the current interest rate is no longer doing the job? Unless they are willing to offer some tough love to the Australian people (and our grandchildren), which is not politically expedient, they will need to keep lowering rates, which compounds the problem.

      It will be interesting to see what type of regulation they bring in to try to keep investors from speculating and driving prices higher.

  4. ellie

    “If the median household income increases to $200,000 per annum, a $1 million home will not seem all that expensive.”

    Did you seriously write this statement? And I wish some somebody , in property market, writes something that’s definite and doesn’t include ‘if’ after every full stop.

    • ellie

      Also …this : “It will be interesting to see what type of regulation they bring in to try to keep investors from speculating and driving prices higher.” says Jason who has educated the same to do so.

      Jason is a personal mentor for Steve McKnight’s Millionaire Apprenticeship Program. He has helped hundreds of investors achieve greater results on their journey to financial freedom. @jasonstaggers

      • Profile photo of Jason Staggers

        Sorry. Until I can either travel to the future or hone my fortune telling skills, I’ll need to be somewhat ambiguous when talking about the future.

        The point was to highlight one of the two ways property might someday become more affordable. Either home prices come down or wages go up. The government and RBA prefer the latter.

        On your second comment…

        Property speculation is the result of artificially suppressed interest rates, negative gearing and a general view that real estate will forever increase in value.

        We try to teach investors to stop speculating and be much wiser in their investing approach.

        Thanks for adding a little excitement to my day :-)

  5. Profile photo of Cattleya

    I’d say the Chancellor’s 2015 summer budget has more of an impact and it started to get into effect in April 2016.

    Before all these, this is how it looks like:
    Rental Income £20,000pa.
    Interest expense £12,000pa.
    Assuming 40% tax rate, the tax payable is £8,000 x 40% = £3,200

    After the new rules fully implemented in 2017 the tax payable is:
    £20,000 x 40% – £12,000 x 20% or
    £8,000 – £2,100 = £5,900 which is almost double of the £3,200 tax above.

    So Rental income is taxed at Gross.
    Only 20% of the Mortgage Interest is tax deductible.
    Wear and tear costs will be more restricted.
    And losses are not carry forward to the next tax year.
    The tax changes are applicable to all new and existing IPs
    There will be a lot of people making a loss on their investments.
    Lending requirements are also made tougher – rental income must be at least 145% of interest expense – meaning a lot more cash up front to get smaller mortgages. In some cases apparently 60% down + stamp duty and expenses.

    Given these new changes, IP profit in UK is very difficult. There will be influx of moneys into Oz property market.

    So what’s happening with negative gearing and IP taxation in general now that we have Coalition govt?

    • Profile photo of Jason Staggers

      Yeah, good point. Didn’t know the extent of the new tax laws. Not to mention the higher stamp duty on purchases of second homes. If Brexit kills home prices, is it possible these changes could be retracted?

      Looks like business as usual for now on negative gearing and CGT discount. But the lower interest rates go, the more pressure will build for government here to make property speculation less attractive.

      • Profile photo of Cattleya

        “If Brexit kills home prices, is it possible these changes could be retracted?”

        I somehow don’t think Brexit is going to kill home prices. 1: Europeans not allowed to come freely to the country. London will always attract the wealthy and professional workers. They will get in, regardless of European free movement, through other visas. The poor Europeans are irrelevant because even in free movements they can’t afford London anyway.
        2: The Demand driving up prices are from investors and wealthy both local and foreigners. So long as there is profit and Capital Gain, proximity to jobs, these will not stop regardless of Brexit.

        Retraction is possible depending on public outcry and the new Chancellor. Today we have a new one Philip Hammond. But the next election is 4 years away so not much chance of ‘public outcry’.

        Oz usually copies from UK. I somehow think Oz govt (even the world?) is watching closely to see how these new regulations impact housing affordability and political repercussions. If it works, they will get ideas and implement a modified version?

        Also worth noting that the new regulations were not discussed at all during the 2015 general election campaign so the public did not have a chance to vote on it. The Tory got majority and the regulations were just presented as a done deal. A lot of people felt betrayed but cannot voice their frustration as other big issues were raging such as Europe – ISIS bombing, refugee crisis, Brexit, etc.

        C’est la vie, I suppose :)

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