The decision by Britain to leave the European Union has sparked shock, disbelief and fear.
The biggest question on everyone’s minds is how does this affect the rest of the world? How a BREXIT could impact Australia?
Hear a summary on this from two Real Estate Talk regulars in Pete Wargent and Michael Yardney.
- What is the EU?
- What were the arguments for and against?
- Is this bad news for the UK economy?
- How will this impact global markets both short and long term?
- How have the markets reacted?
- What are the opportunities and risks for Australia in all this?
- What have been and are likely to be the effects on Australian property markets?
- What should we watch out for – the signs things are going sour?
Kevin: The decision by Britain to leave the European Union has sparked shocked, disbelief and fear. The biggest question on everyone’s mind is how does this affect the rest of the world? I want to know all about that, plus, I also would like to know its impact on Australia and New Zealand, the markets in both those countries.
Dr. Shane Oliver, Chief Economist of AMP Capital, had this to say, and I quote: “And a shock for financial markets, which had been increasingly confident that Britain would vote to remain in the European Union, a victory for the leave outcome by 52% to 48% triggered an abrupt bout of risk-off in financial markets.”
Still quoting Dr. Oliver, he said, “I suspect it was probably also a shock to many Brits themselves, some of whom seem to be going through a bit of Bregret.” All this word blending, it seems to be the common thing.
Let’s get a bit of a summary on this, and I’m joined by two of our regular commentators from Real Estate Talk. Firstly, Pete Wargent. Pete is a chartered accountant, chartered secretary, and has a financial planning diploma. He has achieved financial freedom at the age of 33, as detailed in his book Get a Financial Grip – A Simple Plan for Financial Freedom. Pete now manages his investment portfolio, travels, and works as a consultant in the finance industry from time to time. He is also a Brit, so highly qualified to talk to us on this topic.
Pete, welcome to this podcast.
Pete: Hi, Kevin.
Kevin: And our second guest is Michael Yardney, no stranger at all to our audience. Michael is a director of Metropole Property Strategists, who create wealth for their clients through independent, unbiased property advice and advocacy – there will be a lot of that needed right now. He’s been voted Australia’s leading property investment advisor, and his opinions are regularly featured in the media. He has authored more books, in fact, than I’ve probably had hot meals.
Michael, welcome to this podcast.
Michael: Thank you, Kevin. You better change your diet, mate.
Kevin: Yes, I’m overeating books. Welcome, gentlemen. This is a huge topic, and I’m looking forward to your input on this.
Firstly, Michael, I want to ask you, what is the EU? It’s interesting to note here that unfortunately, this is probably one of the most googled terms right now, “What is the EU?”
Michael: I bet it’s probably very highly Googled in the United Kingdom as well at the moment, isn’t it?
Kevin: Which is a real worry.
Michael: Of course, it is. The European Union is an economical and political union currently between 28 European countries. It was created in the aftermath of the Second World War. I think the intention initially was to foster economic cooperation. I think the ideas behind it were they thought if countries were more economically interdependent, they’d be less likely to fight each other. I’m not sure that that actually worked out that way.
So in 1958, it started the European Economic Community. It was created in ’58, initially between six countries: Belgium, Germany, France, Italy, Luxemburg, and the Netherlands, and that laid the foundations to what today we’re calling the European Union, which – as I said – has 28 member countries, and the total population is 500 million people in those countries.
Kevin: When did Britain join?
Michael: The UK, interestingly, wasn’t an original signatory to what was called the Treaty of Rome. That was in 1957. What actually happened was President Charles De Gaulle – the older members listening to this, I’m sure you and I remember his name – he didn’t want England to be in, and he gave all sorts of excuses. It really wasn’t until he relinquished his presidency and the UK made its third application for membership in 1973 that they joined, but interestingly in England, they didn’t like the word European Community, they tended to call it the Common Market.
Kevin: I do remember that. Is this the first time that the UK has wanted to actually leave since joining in ’73?
Michael: No, they’ve actually tried before. In 1975 – not that long after it joined – the UK electorate was asked to vote on the question “Do you think they should stay in the Common Market or not?” And at that time, there was a resounding vote to stay: 62.2% of people said yes. So yes, they’ve thought about it before, and there have been ructions going on for a long time.
Kevin: Yes, thank you, that’s a good insight there as to what the EU is all about.
We’ll go to you, Pete, because I think you are highly qualified to answer this question: What are the arguments for and against? You must have been following this very closely, too, by the way.
Pete: Yes, sure. As Michael mention, Britain held its referendum to leave the EU and actually voted in favor of leaving, which stunned financial markets, which hadn’t expected that. I think the reason that people voted in favor of leaving is to some extent, there is a perception that Brussels has had undue influence on law and politics. Immigration, a very big issue in Britain, because the European Union allows passport-holders to work and live in a range of countries across the continent.
I think it was also a bit of a protest vote, because a lot of Britain’s regional economies are really struggling, and in some areas, up to three quarters of people voted to leave. The vote is non-binding, it’s not mandatory, but the result should be respected.
Article 50 has to be invoked in order for Britain to leave – so a formal notice has to be given, and even after that formal notice is given, it would likely take up to two years for Britain to actually leave the EU and perhaps up to a decade to actually renegotiate all of those trade agreements, so it would be a good time to be a lawyer.
Michael: So they’re not actually divorced, Kevin. All they’ve said is “I actually don’t want to live with you anymore,” but in the parlance, I think they want to be members with friends.
Kevin: Just getting back to that original question, Pete, what were the arguments for and against?
Pete: I think from an economic point of view, it was generally agreed that it would be better for Britain to remain part of the European Union. The trade agreement is very favorable, the Union being Britain’s largest trading partner. The arguments against: as I mentioned, I think a lot of the votes were actually about immigration and other issues, and in particular, growing inequality between some of the struggling rural areas and the capital city.
In the short term, the implications for Britain: well, we’ll get a new prime minister sooner or later, and given that there’s no credible opposition at the moment, it will be a Conservative PM. Britain’s currency is already devalued, it has lost its AAA rating, so there’s a risk of the UK going into a recession as business investment and confidence takes a hit. Interest rates have been stuck at 0.5% since March 2009 now, but even from here, we could see those interest rates get cut by the Monetary Policy Committee, so it could be a bit of a mess in the short term for Britain.
Kevin: Pete, you obviously still have relations in the UK. What are you hearing from them about the result? Did this come as a bit of a surprise? Because what we hear is that a lot of people didn’t really expect this vote to fall this way.
Pete: Yes, I think it was a big surprise to currency markets, to financial markets, and to people on the ground. A lot of the talk about the youth vote being in favor of staying, but actually, unlike in Australia, they don’t have compulsory voting in the UK, and actually, the turnout in younger generations wasn’t that high, so you could argue that a lot of people weren’t that bothered either way, and yes, Britain could pay the price for that.
Kevin: It was a very long campaign, wasn’t it? Do you think they had become a little bit disenfranchised by the whole thing?
Pete: I think that there was certainly some complacency. I think a lot of people didn’t expect the result, and as a result, a lot of people didn’t vote, including experts such as myself who are based around the other side of the world and didn’t think that such an outcome would happen. I think if there was to be a second referendum, the turnout would be much higher.
Kevin: We’ll just stay with you for a moment, Pete. Michael, we’ll come to you shortly because I really want to get your take on what you believe is going to happen for the Australian and New Zealand markets, but Pete, just staying with you for a moment: the UK, is it such bad news for them, for the economy there?
Pete: In the short term, potentially, yes. There’s certainly heightened risk of another UK recession. I suppose the wider risk, though, is really of contagion – what happens if other EU countries such as the Nordic countries decide to follow suit – and that could in turn lead to breakup of the Union, so potentially then a Eurozone recession, which would obviously be very bad news for global growth.
Kevin: Okay, that was going to be my next question, about how much do you think this will impact global markets, both short and long term.
Pete: In the short term, potentially not that much, but over the medium term, globally, interest rate expectations have already been repriced lower. I mentioned the UK, but also in the US and even here in Australia, bond yields hit their lowest ever level this week. Index swaps did the same thing. So we’re potentially looking at further interest rate cuts as soon as August.
A lot of people don’t really know how this is going to play out, but it’s potentially an uncertain future and a bit of turmoil ahead.
Kevin: Pete, just keen to hear from you how the markets have reacted to all of this.
Pete: From a confidence point of view, markets hate uncertainty, but on the other hand, they may also get bored of the Brexit talk over time, and perhaps that’s already happening to some extent, even after just the week. Initially, the stock exchange in Australia had a little bit of a correction, a few percent last week. The fund managers were out with their usual soothing words. The fact is the Aussie share market has been a bit of an underperformer over the last decade, so to some extent, it’s no wonder that people have turned to property for more reliable returns.
In terms of the actual property market itself, the media said that Brexit could impact confidence, but with that said, Sydney’s prelim auction clearance rate this week was 77+ percent, so if anything, the poor performance of the share market could actually see property add to its safe haven status and the so called flight to quality.
Kevin: Michael, I’ll get your comment on that in just a moment, but just back to you, Pete, on the markets in the UK, a lot of the talk is about how trade is going to be impacted. Is there any reason why, if the UK is not in the EU, that they still can’t trade in the European markets?
Pete: No. Of course, the Union is Britain’s largest trading partner, but the problem that will face Britain is having annoyed many of its trading partners that are in the EU, they will now have to renegotiate their trade agreements – potentially on less favorable terms – and just the disruption in the short term that could impact the UK economy adversely.
Kevin: Michael, what are you seeing in the property markets in Australia?
Michael: Interestingly, Kevin, I’ve noticed a sense of uncertainty. Over the last couple of weeks, investors who I’ve been speaking to are uncertain about things that are happening on the other side of the world, about the UK and Brexit, about the European Union, what’s going to happen with Donald Trump, and the uncertainty in the Australian political environment, as well. That’s making a lot of them just step back for a moment and put their hands in their pockets and not make investment decisions.
Markets – as Pete says – don’t like uncertainty. It’s not as volatile, obviously, as the share markets, so the property markets aren’t suddenly going to drop or go up 5% or 10% in a day, but it’s stopping people a little bit in the short term. But I can see in the long term this uncertainty is going to be good for the Australian property markets.
What people are wondering at the moment is what this is going to do to themselves, to the markets, to the interest rates, but the honest answer is no one really knows what’s ahead with the financial markets, and that’s why the markets are all over the shop, Kevin.
I remember when I first heard about the subprime crisis over in the United States, I thought “Oh, that’s way over there; it won’t affect us here,” but it rippled around the world, and as Pete has suggested, this could be the beginning of a house of dominoes falling over as a number of other countries are considering leaving the economic union, as well. So I think we have to watch it carefully but not have a kneejerk reaction.
Kevin: Yes, I guess a kneejerk reaction is going to cause a lot more risk, isn’t it? How would you assess the risk right now, Michael?
Michael: It depends on which markets we’re talking about. In the residential real estate markets, one of the things that has underpinned it in the last couple of years is foreign investment, particular Asian investment. According to Colliers, an international estate agency, Britain has been one of the top destinations of foreign – particularly Asian – investment, and then Melbourne and Sydney.
I believe that we’re now going to be perceived as a safer environment, and money is moving to safe havens, just like it is to gold in the financial markets. So I can see that more foreign investors are going to – if they’re allowed to by our banks and the government – put money into Australia, which is a more secure political and economic environment. That may actually prolong the property markets a little bit longer, especially in those new and off-the-plan markets that are starting to hurt a bit.
As Pete suggested, I believe interest rates are going to come down. The market has factored in a high likelihood of an interest rate drop in August, the August announcement, possibly even in July, and for that reason, that’s also going to prolong this property cycle, underpin them as affordability increases.
So on balance, Kevin, I think it’s not going to have any negatives for us with regard to property, but the uncertainty is going to just make us feel a little bit uncomfortable
Kevin: That’s short and long term, Michael when you say no negative impacts for us?
Michael: I don’t really know what’s ahead; I don’t think anyone does. As Pete said, it could take a minimum of two years, and it could be many more years before that, because there are lots of new trade agreements that have to be reached. Even so, there has been a petition since that referendum with millions of votes on it saying “Let’s have another referendum, because we didn’t really know what we were doing.” So it may even change again.
Kevin: Yes. Gentlemen, I’m going to ask you to give me some summary and key points in a moment, but Pete, I want to go back to you, if I could. What do you see as the signs that we should watch out for, the signs that things are starting to go a bit sour in the Australian market?
Pete: Are we talking property markets or financial markets?
Kevin: A bit of both, actually.
Pete: In terms of the property markets, Michael has touched on a couple of the conflicting signals. I think one of the things that he touched on there is bank lending to foreign investors. The banks have pulled up the ladder in the last month or so – a lot of the majors have – so that could certainly slow some of the new property settlements, certainly those high-rise apartments, which are often 40% or 50% sold off-shore. I think there could be some settlement risk looming in that sector.
But there are other factors at play. I think we mentioned some months ago on the show, there will be changes to visa rules from 1 July, so that will make it far easier for primary-school-age students and their guardians from Asia to come and live in Australia, so that will help to increase population growth again, and we’ve seen a bit of a rebound over the last six months.
I think over the short term, it’s always very difficult to say. I think over the longer term, though, the fundamentals of Australian property in terms of population growth are still very strong, but that said, if you’re looking at properties, you want to find something with scarcity value, because those are the property types that will outperform.
Michael: Pete said it so well that there’s very little else to add. I believe that one should have a strategy, and as long as any investment decision or home-buying decision fits in with your strategy, these outside factors will affect us in the short term and there will be lots of noise, but it shouldn’t take your eye off the ball in the medium to long term. Property values in the well-located parts of the capital cities of Australia are going to increase because of scarcity, because of our strong population growth.
The fact that now it takes so long to commute to the outer suburbs means that the inner ring and middle ring suburbs are going to increase in value disproportionately, so buying well-located properties close to the transport nodes, close to public transport, properties that will have owner-occupier appeal, what I call investment-grade properties are still the right thing to do.
And if you’re a long term investor, during these times of uncertainty, be fearful when others are greedy – as Warren Buffet said – but now is the time to be greedy when others are fearful.
Kevin: I guess you touched on it earlier, too, Michael, about the GFC, and I think we’ve become a lot more cautious in the lessons we’ve learned from that, but one of the things we don’t have is that enormous buffer that the federal government had when we were going through that GFC, which we don’t have now.
Michael: That allowed Australia to spend its way through the GFC by giving out Pink Batts and first-home owner grants and infrastructure spending. You’re right; our government doesn’t have that facility currently, but I don’t think anyone is suggesting that Australia is heading for a recession. Most of our trading partners are based geographically locally within Asia and then there’s the United States, so Europe and the UK don’t make up a big part of our general trade, and for that reason, the contagion may not spread as far as out as Australia.
Kevin: There’s also hope that there might be a few more trade opportunities for Australia in what’s going on, as well. Pete, is that right?
Pete: As most of you know that Australia has been through a very big ramp-up in exports of coal and iron ore to China, but also services exports are now growing strongly. As Michael mentioned, Australia’s key trading partner is China. The economy there has slowed from its rampant levels of growth around 2007 when it was growing at 13%+, but it’s still ticking along at a fair click They’re going at well over 6% per annum, and demand there is still pretty strong for our bulk commodities.
Kevin: Gentlemen, it’s been great talking to you. Thank you so much for your very valuable time and a great insight into what’s happening.
Pete Wargent and Michael Yardney, thank you for your time.
Pete: Pleasure, Kevin.
Michael: Thank you, Kevin. It’ll be really interesting to look back in 12 months’ time, won’t it?
Kevin: It will indeed, Michael, in which case we might make a date and do exactly that. Thanks again.