Here’s a great email from Simon @ Results Mentoring:
Welcome to The Sophisticated Property Investor, our controversial eNewsletter for smart property investors. In this edition, we’ll take a look at the potential and the perils of investing in mining towns, and reveal our Top 10 Success Secrets for Mining Town Investments!
It’s a big topic with a lot to cover, so grab a cup of your favourite brew, sit back, and let’s get started…
What’s The Big Deal With Mining Towns?
Property magazines are full of articles about mining boom towns at the moment, often profiling young investors who’ve bought property in the towns and made big gains through high capital growth and positive cash flow.
The severe accommodation shortage in many mining towns has led to soaring rents, in turn giving rise to positive cash flow opportunities. The promise of very high rental returns has attracted many investors, leading to upward pressure on property prices.
Websites and property expos are now teeming with companies offering opportunities to purchase ‘off-the-plan’ units offering high rental yields in mining towns – often in excess of 10 per cent!
With this kind of publicity and the potential returns on offer, it’s easy to see the appeal – especially when these returns are compared to the flat prices and average 4-5 percent rental yields in metropolitan centres around Australia.
And aren’t we a resources-driven economy? So shouldn’t it make sense to ‘go where the money is’ and invest in the towns that are the engine room of the mining boom?
There’s no doubt that high returns are possible. In fact several of our Results Mentoring students have recently acquired properties in mining towns that deliver 5-figure positive cash flows even after all holding costs (including loan interest) are deducted. And indeed rising property values in many mining towns have outstripped growth in capital city prices in the last 2 years.
It’s easy to be blinded by promises of high returns, but (as with any investment) before deciding to buy anything it’s important to analyse the risks.
Safe As Houses?
There are several categories of risk which need to be taken into account when considering a property investment in a mining town, including:
- Risk of Government Intervention
- Reliance On Demand For Resources
- High Holding Costs and Property Management Issues
- ‘Achievable’ Rent Versus ‘Promised’ Rent
- Housing Supply Risks
- Rental Market Manipulation
Let’s look at each risk are in turn…
Risk of Government Intervention
Anyone who was investing in mining towns in 2010 probably gets a knot in their stomach thinking about what happened when the Federal Government first proposed a ‘Super Profits Tax’ on mining companies.
Concerns and uncertainty about the proposed Super Profits Tax had a significant impact on many mining towns, leading to several large projects being put on hold. With less work, less people needed to travel to the towns, resulting in higher vacancy levels and downward pressure on rents in affected areas.
Uncertainty is poison for investment, and so fears about the impact of the proposed tax on mining companies meant fewer investors were willing to buy properties in the towns, temporarily undermining property values as well.
An announcement about a new tax might be a rare event, but there are other factors that can affect mining companies and property values in the towns within which they operate…
Reliance On Demand For Resources
An obvious risk with many mining towns is the reliance on the fortunes of a single sector of industry. As was seen at the onset of the Global Financial Crisis, and the resulting recession in most developed countries around the world, a fall in global commodity prices (the prices of resources like gold, iron ore, coal etc) can have a drastic impact on the mining industry.
Fortunately for Australian mining towns, demand for Australian resources actually remained high during the GFC, largely due to orders from China and India, which helped to sustain commodity prices once the initial panic had passed.
International demand for Australian resources continues to be strong and largely underpins the Australian economy. The projected investment in mining projects and related infrastructure over the next few years is massive – running into hundreds of billions of dollars!
But lately there has been talk about a potential fall in demand for Australian resources due to slow down in China’s growth. China’s position as Australia’s largest trading partner for resources means that if demand from China does fall significantly (and is not offset by demand from other developing nations such as India), then a fall in Australian commodity prices may result.
A substantial fall in commodity prices may lead a mining company to make cutbacks or even close a mine. Closure of a mine will mean significant loss of jobs in the area, which in turn can have a catastrophic effect on rental demand and on property values.
The history of some mining towns around the country bears evidence to what happens to the local property market when a mine shuts down. Some never recover, becoming abandoned ‘ghost towns’.
And ‘getting in early’ when a new mine has just begun production, isn’t necessarily any protection… In 2009 BHP closed a $2bn mine at Ravensthorpe in WA just months after completing construction, at a cost of 1800 jobs, crippling local towns.
Mining companies are first and foremost driven by a profit objective. If it becomes commercially unprofitable to run a mine due to falling global commodity prices, then the mining company won’t hesitate to scale back or shut down the facility.
While you can’t control international commodity prices, or the commercial decisions of mining companies, some of the risk of vacancy or variability in rents over time can be mitigated by the kind of lease you seek for a mining town investment property.
For example, rather than renting to transient contract mine workers (and suffering the risk of vacancies or volatility in rents), could you negotiate a long-term (say 3 year) corporate lease with the mining company itself? With a lock-in corporate lease, the mining company must keep paying over the term regardless of whether the property is occupied or vacant.
It’s also important to keep a very close eye on the performance of global commodity markets for the particular resources mined in the area, and be ready to move swiftly should adverse trends materialise.
High Holding Costs and Property Management Issues
Other issues in mining towns may include a lack of available tradespeople to carry out maintenance on properties in the area, or a lack of property managers.
Many investors are surprised by the often higher outgoings for mining town properties, such as higher insurance premiums, fire protection levies, water rates, property management fees, unusually high body corporate fees on units, etc.
Any of these issues may increase the costs of holding the property to the point where what seemed at first to be a positive cash flow ‘goldmine’ becomes a negative cash flow ‘money pit’!
Before buying a property in a mining town or isolated area, make sure you carry out thorough due diligence on the deal. This includes determining the current demand for rental accommodation, expected longevity of the local mines, availability of tradespeople and property managers, and verifying all outgoings associated with the property.
‘Achievable’ Rent Versus ‘Promised’ Rent
In the last couple of years a number of property development companies have emerged in mining towns, offering ‘off-the-plan’ units with promises of rental yields over 10 per cent.
BEWARE! Your due diligence on such a deal should include confirming whether the promised rental yield is actually guaranteed, and – even more importantly – whether the rental yield is sustainable.
Many an investor has come unstuck where they’ve paid a premium and bought into the promise of high rental returns, even a rental guarantee for 6 or 12 months, only to find that the reality is very different once the guarantee period comes to an end.
Some unscrupulous developers will simply build the rental guarantee into the price of the property, i.e. inflate the price of the property by the amount they’ll have to fork out for an artificially high rent during the guarantee period.
When the guarantee period ends, the property deal that looked great on the numbers at the beginning suddenly has to take a significant ‘haircut’ on rent in order to keep it tenanted!
Worse, having paid too much, the investor might discover that the realistic market value of the property is actually less than the bank loan, putting the property into a negative equity position.
If considering an off-the-plan purchase, ALWAYS validate the price against other comparable COMPLETED units in the area, to make sure you’re not paying an artificial premium.
And if there’s a promised rental return, don’t rely on a ‘rental guarantee’ that might not be sustainable. Insist on including a condition in your purchase contract that the whole purchase is subject to a real tenant being put into the property on a fixed-term lease prior to settlement, with both the tenant and the terms of the lease having to be “to the purchaser’s satisfaction in all respects”.
Housing Supply Risks
Prices and rents in mining towns are driven up when there’s a shortage of available housing compared with the demand for housing in the town.
Rents (and property values) will stabilise and possibly fall if new rental accommodation is made available at a faster rate than the rate of population increase in the town, leading to an over-supply.
What could cause a significant increase in the housing supply in a mining towns? An obvious possibility is the development of a new housing estate, or a large scale development of units/apartments.
Some mining companies are even building their own houses – either for the purpose of accommodating their own staff, or as a required contribution to community housing needs. For example, as a condition of approving the $4 billion Caval Ridge Mine near Moranbah the Queensland State Government required the BHP/Mitsubishi Alliance (BMA) to build 400 new homes, with 160 of these due to be provided in Moranbah by June 30, 2013.
But the dynamics of mining towns give rise to another, less obvious way in which the supply of rental housing may rise all of a sudden…
Remember that not all housing in these towns is already owned by investors – a reasonable proportion is currently owner-occupied. An influx of investors paying premium prices can result in home owners ‘cashing-in’ by selling their property to an out-of-town investor, and then leaving town – suddenly increasing the supply of vacant properties for rent.
Moranbah, for instance, became a ‘flavour of the month’ among mining town investors in late 2011. The supply of vacant houses for rent rose in a short space of time, at least in part due to the transfer of a large number of houses from home owners over to investors (with the former home owners then leaving town rather than staying back and renting). Supply ran ahead of rental demand in Moranbah, and there may be a lag before the available supply is soaked up.
Rental Market Manipulation
With the rate at which rents have risen in many mining towns over the last couple of years, it’s hardly surprising to see some of the bigger miners looking for ways to contain the substantial accommodation costs involved in housing workers in these towns.
In some instances it can actually be cheaper for a mining company to fly personnel in at the beginning of a day, and fly them out at the end of the day, than it is to rent properties in the town. Constructing temporary accommodation ‘villages’ can also be more cost-effective for a mining company than leasing established houses.
Either option helps reduce the demand for rental accommodation in the town, taking away some of the pressure on rents.
We can see these approaches reflected in moves by BMA in 2011 where pressure was put on the Queensland State Government to allow a 100% Fly-In/Fly Out (FIFO) arrangement for the huge Caval Ridge Project, and to approve a 2500 bed accommodation village to service many of the FIFO workers.
The Top 10 Success Secrets For Investing In Mining Towns!
Investing in mining towns isn’t for everyone. You need to be prepared to accept a certain level of risk, and to take steps to actively manage the risks.
However, no form of investing is without risk. If you’re looking for an absolutely safe investment, where there’s no risk of something going wrong, then you shouldn’t be investing in property at all!
Done right though, a mining town investment can be lucrative and may well fit in with an investor’s financial goals.
Here are our Top 10 Rules for investing in mining towns:
- Choose a town with multiple resource companies and varied industries, in order to reduce reliance on the demand for a single commodity.
- Seek areas with scarce land and/or high building costs, keeping vacancies low and rents high.
- Secure a long term lease (e.g. 3+ years) directly with an established large company or government institution in the town, rather than renting the property to transient contract workers, to minimise the risk of vacancy and ‘insulate’ yourself somewhat from variations in the industry.
- Choose a house with land, rather than a unit. This avoids body corporate costs and opens up future redevelopment potential, which may mean the property outperforms on growth over time.
- Buy on net returns, not gross rental yield. Take the time to research and confirm all anticipated ongoing costs involved in holding the property, and deduct these from the rent to assess the actual cash flow (positive or negative) that the property will generate.
- Buy for the short-medium term, not for the long term. While there may still be a significant run left yet in the current mining boom, eventually the house prices and rents in the mining towns will fall back – either due to increasing housing supply or falling demand for resources.
- Never buy ‘site unseen’. Know what you are getting into! The only time we might consider breaking our own rule here is if we have a relationship with someone else who can be our trusted eyes on the ground, and if we first obtain full detailed reports on the property from both a building inspector and a local property manager.(As an aside… Property managers can be a very useful source of insights into the nature of the street and the local neighborhood. Most property managers don’t want to take on a house that will be a hassle in terms of delinquent tenants or local criminal elements, and are in our experience likely to be quite up-front in voicing their opinions if they think it will be a problem property!)
- Avoid putting all your eggs in one basket. Consider diversifying across different mining towns or different types of location and property altogether. If a particular town or commodity is adversely affected, you don’t want this to bring down your entire portfolio.
- Don’t over-extend yourself. Prices, and therefore bank loans, can be quite high in many mining areas. Know whether you can sustain the holding costs on a property if you have to carry it vacant for a time. Always have a ‘safety net’!
- Don’t get fooled into thinking that a mining town property will be a ‘passive’ investment. Invest time in ongoing research, monitoring, and ideally spending a fair bit of time in the area yourself (to keep tabs on sentiment, local developments, etc). This investment of time may be critical to the overall success of the investment.
Follow these rules, and you’re much more likely to see a successful, profitable outcome on your mining town investments!
Until next time…
– Simon Buckingham