Mining Towns and Bad Advice

The following is an extract of an email I recently sent to a client who had been convinced by someone that an investment in Karratha was a sound idea…

As for developers and real estate agents they  have a clear interest in talking up the market.  But many so-called “property investment mentors” also have direct financial interest.  This is from an article in the Property Observer July last year titled “Port Hedland and Karratha “the best places to buy”? Don’t get roped into that one”  read the full article here
Another more recent article on what is happening in other mining ‘boom’ areas  where he points out “The decline in these markets is not just about hard times in the iron ore and coal sectors. It’s also about over-building by developers and a failure to appreciate the full impact of the growing use of FIFO ( fly in fly out) workforces accommodated in temporary workers villages.”
We have many successful clients with strong property property portfolios and some of them did well out of the mining boom, buying ahead of the market.  We also have some clients who didn’t – this is a recent example I came across:
I foolishly I bought in Blackwater and Mackay when rents were crazy and out look was bright. Now rents in Blackwater have gone from $950pw, purchase price $495k to now $350pw and an agent told me today if I sold now I would expect $200k as there is zero interest in a property like mine. Mackay is a similar story, rent $700pw, PP $485k to $300pw and a $380k expected sale price. I am currently on a fixed rate for the next few years of 4.89%.
This person has little choice other than to sell their  family home in Sydney losing all of their  equity.
So my negative attitude to your Karratha strategy comes from my experience over the last 15 years.  Keep in mind that lenders also know about booms and bubbles – although they appear to have completely ignored that in the case of many mining areas.  However for a lender the ideal property is a 3 bedroom brick & tile house within 20 kms of the CBD or a large regional centre.  As you deviate from that either way, such as a one bedroom bet/sit or a $5 million harbour-side mansion the size of the market for these properties decline and that makes lenders nervous as when things go wrong they want to be able to sell easily and the bigger the market the easier the sale.  As a result lenders will lower the equity share on property that has a restricted market by as much as 50% and in many cases lenders will decline to accept a security.
Typically regional areas offer higher rental return over metropolitan areas however the cities ( Melbourne & Sydney ) offer better capital growth.  You have stated that you are looking for a positive geared strategy with good future income flow.  In my experience any ‘residential’ property with a return in excess of say 6.50% starts to ring alarm bells.  I am not saying they don’t exist but let’s look at some of the common scenarios:
  • serviced apartment or student accommodation – management or zoning restrictions limited market results in 60% LVR (loan valuation ratio) at best
  • studio apartment under 40 sq metres – again restricted market, LMI ( mortgage insurance) not available further restricting market expect 60% LVR
  • hobby farm > 5 ha – restricted market 60% LVR
  • retirement village – restricted market and management restrictions – unacceptable security
  • converted hotel/motel – unacceptable security
  • guest house / student housing where tenants share common areas – usually unacceptable
  • remote locations dependent on single industry – case by case
  • rural/ regional towns under 10,000 pop – case by case but typically 60% LVR
  • resorts / holiday letting – strictly speaking they are not ‘residential’ ie: people do not reside there, usually unacceptable
  • display homes – very restricted depending on agreement may get 70% LVR
  • property with rent guaranteed  – these are usually a managed arrangement or an incentive from the developer, will be assessed at market rent and equity probably discounted
While all of the above (and many others) offer good rental yield you have to keep in mind that the equity restrictions mean that you have to use more of your money and  this will ultimately reduce your ability to acquire more property.
While Melbourne struggles to make a 3% rental return, Sydney around 4% there are parts of Brisbane and I am sure other major centres where 6% on standard property is achievable. If you are looking for property that pays its way and makes a real profit, you will probably be forced to look at the higher risk options above.  If you are looking for property that can start to pay itself off, gradually becoming more genuinely positively geared over the longer term and capital growth is not your focus then larger regional centres may be your best option.

Household Income Increases

A new report by Real Estate Investar on household income increases from 2006 to 2011 broken down by suburb shows some very interesting results

The number one suburb is Birtinya in Qld’s Sunshine Coast with 227% increase albeit from a low base of only $540 per week in 2006.  Second place is North Coogee WA with 146% increase from $1113pw to $2738 in 2011.  However 3rd place is a surprise with Noarlunga in SA.

As to be expected WA’s top 50 suburbs performed well ranging from 40% to 146% while NSW ranged from 39% to only 79% and Vic 32% to 82% but the stand out state is Qld with a range from  41% to as mention 227% increase at Birtinya.  Another interesting fact from Qld results is that while rental yield is still very good ranging from 4.5% to a  ridiculous 9% in Halifax – the rental yields fell by on average 20%  probably impacted by the mining downturn.

First Home Buyers Endangered Species

While there has been a lot of hype regarding the current growing property wave in Sydney, Melbourne and Perth.  The  investor driven bubble is very much a metropolitan event with many regional (non-mining) areas still deep in the doldrums.

The other market showing no improvement is the first home buyers market where despite a 4.4 percent seasonally adjusted rise in finance commitments for September – the proportion of first home buyers are at their lowest since statistics commenced in 1991.

There has been a growth in new home commencements and it is possible that the few first home buyers in the market have been driven to this segment as it is the only area where serious incentives are still available.

Sentiment still flat despite RBA’s 50 basis point cut

Despite the 50 basis points cut, the latest Westpac Melbourne Institute Index of Consumer Sentiment showed an underwhelmed consumer sentiment as it rises a bare 0.8 per cent, from 94.5 index points in April to 95.3 in May. Consumer sentiment reading below 100 implies that there are more pessimistic than optimistic consumers.

Bill Evans, Westpac’s Chief Economist, shared that the sentiment was lower than expected saying, “This is a disappointing result. It follows a surprise 0.5% cut in the official cash rate by the Reserve Bank and extensive media coverage that the unemployment rate had fallen from 5.2% to 4.9%.”

The low consumer sentiment was said to be due to lenders not passing on a full rate cut and the unstable European financial condition. Evans stated, “Other factors appear to have offset these positives. Firstly there might have been a degree of disappointment amongst households that the standard variable mortgage rate was reduced by ‘only’ an average of 0.37%. Secondly, increasingly disturbing news around Europe and specifically Greece is likely to have unnerved households.”

Evans went on saying, “We saw some similar evidence around these two factors in December last year. At that time, despite a 0.25% reduction in the official cash rate, the Consumer Sentiment Index actually fell by 8.3%. A number of issues appeared to unnerve households. Firstly, and most importantly, concerns around the situation in Europe and secondly some confusion around the flow on to the mortgage rate as banks delayed their decisions after having responded rapidly following the first official rate cut in November. This issue around mortgage rates was also likely to have been a factor behind the 5.0% fall in the Index inarch following a surprise increase in mortgage rates of 0.10-0.12%.”

The RBA slashed 50 basis points on the interest rates to 3.75% on May 1, the only biggest single cut made since the global financial crisis occurred but the aim to target weak economic growth and confidence seemed to fail.

“This soft response in Confidence will be a disappointment for the Reserve Bank. It seems extraordinary that the Index is 2.0% below its level in October last year when the official cash rate was 4.75% – a full 1% above the current level.”

The federal budget could have also affected consumer confidence. Evans added, “An additional explanation for this weak response of the Index is around the Federal Budget. We asked a supplementary question in the survey, “What impact do you expect the Federal Budget to have on your family finances over the next 12 months?” The results were disappointing with only 9.9% of respondents indicating that the Budget would ‘improve’ family finances while 36% indicated the Budget would ‘worsen’ family finances. Around 50% expected no change and 4%,’did not know’. It appears that the Budget was not a positive for Confidence but this result must be assessed in the light of previous Budgets. The same question in 2011 found only 6.5% expected last year’s Budget to ‘improve’ family finances with 36% – the same reading as in this year’s survey – saying they would ‘worsen’. Overall, it is reasonable to conclude that recent Budgets have not been constructive for confidence although the 2012–13 Budget has been a little more positive than last year. Indeed, the Index fell 1.3% in May 2011 compared to this month’s0.8% rise.”

Evans believes the low consumer sentiment could be a reason for the RBA to cut rates again. “It is our current view that the Bank will wait until July before it cuts again but developments overseas along with today’s evidence that the recent cut has had little impact on Confidence could easily see the Bank bring that decision forward to the next Board meeting in June.”

Margy Osmond, chief executive of the Australian National Retailers Association shared that she was also surprised of the flat result stating, “With a 50 basis point drop in the cash rate and significant family payments in the federal budget retailers expected confidence to rally. And while an uptick is better than a decrease, it’s still a concern that people feel so under pressure with their finances.”

A previous report from the Boston Consulting Group revealed that many Australians are anxious of the possibility of the global downturn. A BCG spokesman stated, “Australia might be half a world away from the European financial crisis and the high unemployment levels of the northern hemisphere, but Australian consumers are just as battered and cautious as those in the U.S., the U.K. and many other developed countries.”

CommSec economist, Savanth Sebastian, shared that the main reason why many Australians feel like so is because they know the of the global environment’s uncertainty, which at the moment is made evident by what’s happening in Greece.”Those fears are firmly entrenched among consumers. There is a sense that the global financial crisis isn’t really over,” Sebastian stated.


Australian economy could benefit by Eurozone woes

The Eurozone’s unstable economic and financial conditions could bring it to collapse in the future but if it ever happens, the collapse could benefit Australia as it could be seen as a capital safe haven.

Former treasury official, Ken Henry, said during an interview at ABC’s 7:30 that “the events occurring in Europe will also predate large capital movements, indeed they are, this extreme capital market volatility, not extreme I shouldn’t overstate it but there’s considerable market volatility at the moment, very important question. If the worse thing happens where does the capital go? It is quite possible of course on this occasion some of that capital will come into Australia, it is quite possible, it is quite possible on this occasion Australia will be seen as offering something of a safe haven for global capital movements. That’ll be the first time in the post war period but it’s possible to imagine it now.”

Henry, who worked ten yearsin the treasury, has also been former Prime Minister Rudd’s adviser during the GFC.

When asked if, “Europe’s collapse could be a good thing for Australia?” Henry said it depends, that being an economist, he would say yes or no as, as Australia could have access to international capital. “It’s maybe even likely that any capital flow associated with problems in Europe would make it easier for Australia to fund it current account deficit, on the other hand it would mean a high valued Australian dollar and as you know that’s an issue already causing some concern for some sectors of Australian [economy],” stated Henry.

The Reserve Bank of Australia shared in its minutes of its monetary policy meeting that there’sstill hope for Europe stating, “In Europe, aggregate measures of consumer confidence had improved and exports had picked up.”

Henry shared the reason why he believes the Eurozone will not survive, is the failure of sharing wealth among member states.”Personally, I’ve never seen how the euro would work. I’ve never seen how it could be expected to work without a genuine fiscal union,” stated Henry.

Henry shared the difference between the Eurozone and Australia. ”People in Australia understand that without our system of horizontal fiscal equalisation, without fiscal transfers from one state to another state, this federation would simply not hang together.”

”People in Australia understand that, people in Europe have not understood that and they need to understand it,” added Henry.

Keeping It Simple No Obligation no inquiries on your credit file
Provide some contact information and brief background and your broker will be in touch usually within the hour