Mining Towns and Bad Advice

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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 http://bit.ly/1vAaAex.
Another more recent article on what is happening in other mining ‘boom’ areas http://bit.ly/1v7OLID  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.
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