Risk v return: Is investing in single industry towns a good idea?

Is investing (or should one say, “speculating”) in single industry towns a good idea?

In a word – no.

Single industry towns typically offer a poor risk versus return equation and can represent excessively perilous locations in which to purchase an investment property.

Two of the main advantages of residential property are that everyday investors can generally use greater leverage than they can in other asset classes, and due to only a small percentage of the housing stock turning over in any given year, price movements generally tend not to be volatile.

However, just as a sportsman’s greatest strength can also be his Achilles heel, so it is in real estate investment.

Australia is now coming down the other side of the mining construction boom with intention surveys suggesting a capex bust which could be one for the ages.

Using high levels of debt in an illiquid asset where there is a sustained or drawn-out price reversal means that punters can be stuck with a leveraged investment which is steadily declining in value, which is just about the worst thing an investor can do.

That’s why I only recommend investing relatively close to the centre of the largest and growing capital cities for the long-term.

Risk v Return

Of course, the concept of risk v return holds that if you pick the right town and you are not using excessive leverage, then it is possible to make fast gains in single industry regions.

Massive price gains in the Pilbara during the mining construction boom proved this to be true.

But the flip side is that if you don’t get out again before the market peaks, there may be very few willing buyers on the way back down the price curve.

We have seen this in the Pilbara too, plus plenty of other regions which were tipped as hotspots in 2012 based upon the false premise of a mining construction boom that was – somewhat ridiculously – supposedly going to go on for decades.

Cash buyers or those with 50% plus deposits may be more willing to take on such a risk, but generally speaking, it is too risky a proposition.

Macroeconomic Environment

OK, with all the above caveats and disclaimers out of the way, are there any towns or regions which are set for such a boost in 2015 and beyond?

Indeed there are.

If you study and have a basic understanding of Australia’s macroeconomic environment then the answer to this question should write itself.

Australia is now coming down the other side of the mining construction boom with intention surveys suggesting a capex bust which could be one for the ages.

Meanwhile, as engineering construction collapses globally bulk commodities markets have been flooded with supply as the new mines come online and pump export volumes out at a record pace.

What does this mean for property markets?

Two things – a cash rate set to decline to a record low of perhaps 1.75% by 2016 – which will fire up some of the investor-heavy inner ring capital city markets – and a currency which has rapidly dropped off a cliff from around 110 US cents to below 78 cents.

 

 

 

 

 

 

 

 

What about regional towns and cities?

Summarily, the towns and regions which are likely set for a property market boost include tourism regions and those with a heavy emphasis on dollar-exposed industries.

There are several regions which immediately spring to mind.

Firstly, these include a couple of Queensland’s major coastal tourism regions.

Secondly, there is also a conurbation in tropical north Queensland which is long overdue to pick up after suffering a diabolical property market performance for the past decade and a half.

Be wary, however, as unemployment rates are elevated up in parts of the north, and these can be both volatile and illiquid markets.

And thirdly, while parts of Tasmania were clobbered by the dollar as it soared towards 110 cents against the US dollar, there should correspondingly be some relief as the dollar has  been dumped all the way back to 78 cents.

Ask yourself how would you cope with a four week vacancy? Or a 4 four month vacancy? If the answer is “not too well” then steer clear.

A word of warning, though – some of Tasmania’s industries such as forestry will never regain their former glories – one of Australia’s most established companies Gunns was thrust into administration an subsequently there were suggestions by the administrator of the grand old company having traded while insolvent.

Hobart’s property market appears to be tightening considerably, which suggests a “landlords’ market” is finally arriving after no price growth in real terms over the past decade.

There are several such regions and towns which could well see a 20% or more uplift in property valuations.

But I still wouldn’t recommend investing in them. Sure you might get a 20% uplift, or perhaps even more, but then what?

Investment Strategy

Investing in residential property in growing capital cities can work well over the very long-term as an inflation hedge since new properties must be built to house the immigrant population and they will always be built in today’s dollars and at today’s construction and labour costs.

High transaction costs and capital gains taxes upon subsequent sale reflect that property does not generally work well as a regularly traded asset.

Over the long-term dwelling prices can be driven higher by:

• a growing population; and
• the growing wealth of that population.

While you might see either or both of these in a single industry town for a period of time, it is unlikely to be a sustained dynamic, and much of the wealth from an economic boom tends to filter back to capital cities in any case,

If property prices do genuinely take off in region then land is often released for development resulting in a glut and a corresponding market crash, as we have seen in some of Queensland’s coal towns, including Moranbah.

Ask yourself how would you cope with a four week vacancy? Or a 4 four month vacancy? If the answer is “not too well” then steer clear.

Furthermore if you hear vested interests in a market using phrases such as the following, alarm bells should probably begin to chime:

“Only 15-20% of employment in this region is employed in mining/tourism/forestry/other industry” – directly perhaps, but what about indirectly in related services industries.

And anyway, if unemployment rates are rising, 15-20% is a very significant figure.

“It’s only a blip, this will blow over” – is the commentator qualified to opine on the industry outlook? Particularly if until only recently they thought the boom times would last for decades?

Timing the market is tough

Of course, like most markets, residential property is chock-a-block full with folk who think they are smarter than the market.

But, just as most drivers on the roads believe they are “better than average”, by definition they cannot all be correct.

And indeed, they aren’t.

You only have to look at some of the recommendations by expert advisors in the media over the past six or seven years – in fact, even over the last three – to know that picking regional property hotspots can be a hit-and-miss game.

Since the market bottomed in 2009, meanwhile, we have seen capital growth of around 78% in London on the Office for National Statistics indices.

In Sydney we have seen capital growth of around 60 since that time, with another massive year of price growth ahead.

For long-term sustainable capital growth – and a more accessible price entry point – investors should also consider inner ring Brisbane, in those suburbs with constrained supply (there are several which are not) and very low unemployment.

Instead as a property investor you should leave the single industry towns for the gamblers and construct a plan to compound or snowball your wealth for as long as you live.

The wrap

Remember, businesses and industries tend to have a life cycle, which is why for most average investors it is much safer to acquire assets which they can onto hold forever, such as an index fund.

This “all caps” approach works because all industries will not simultaneously decline, and if one company falls upon hard times, then another business from a different industry steps up to take its place.

And it’s a bit like this when investing in property in capital cities.

The majority of jobs in the modern era are in the services sphere, with finance, banking, insurance and healthcare likely to be amongst the most thriving sectors.

Basic common sense dictates that investors should acquire property within easy commuting distance of where the great bulk of those jobs are located, in landlocked and supply-constrained suburbs, and hold on to them for the very long-term.