How Brexit Could Impact Australian Property Investors

The 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

The 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

I’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.

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.