The dark secret behind single industry towns

6th May 2015By: Margaret Lomas

Many people know of my preference to be able to get a positive cash flow (or as close to it) from my property purchases – in fact, Peter Switzer loves to call me the Cash Flow Queen! In past books I have written about this, and in my own portfolio, I have successfully added many such properties at various times.

However, what I have noticed of late is that this message of how useful a positive cash flow property can be to all investors, regardless of the entity in which they are buying, has somehow now been translated to being known as my sole philosophy and strategy! The fall out of this is that I come across investors all of the time who are so focussed on finding that next high yielding, great cash flow property, that they end up acquiring property which might have good rent returns, but is in danger of not growing due to an absence of important growth drivers.

Single industry towns

It’s also a fact that many properties which have the capacity to deliver good cash flow exist in areas where there is a reliance on a single industry. Property in these areas tend to get a higher rent return, as rentals are often in demand by workers in that industry. Such towns tend to get a higher than usual rental yield for many reasons, including:

  • They exist well outside of major urban areas, and so the property values are low, creating a higher relative yield.
  • Where the industry in question is experiencing a robust period and demand for its product, extra workers are usually employed. These workers often cannot be sourced from within town, so they are recruited from elsewhere and move to the area, and;
  • As many of these workers are itinerant – at least until it can be confirmed that their continued employment is assured – they do not usually buy. So, although the industry is doing well, the expanding population are not property buyers, and pressure is not brought to bear on values. They are, however, renters, and this is why rental yields often soar.

Property in such areas then becomes an attractive proposition, because initially, the cash flows look fabulous. This in turn attracts more investors and property prices begin to move. Of course, we then see an artificial property boom, but this has been brought on purely by the existence of the single industry and the resulting hordes of hungry investors seeking, at first, good cash flows, and then the spin-off gain.

Nothing lasts forever

It doesn’t take much to reverse the fortunes of those who invested – a change in the industry, an economic downturn, and a fluctuating Aussie dollar are just a few of the many influences which can take a whole industry and wipe it out in a matter of months. Rents fall dramatically within weeks and the great returns turn into dismal yields. And, since property is so illiquid, any investor trying to sell when the peak has been reached and the fall has begun, will take whatever they can, creating widespread discounting and removing value from every property in town. This very situation is being experienced right now in mining towns such as Moranbah and Karratha and the devastation for many is evident.

And while many experts may say that where property in concerned, ‘time in market’ is key, in fact these towns require precise ‘market timing’ if the strategy is going to work. You need to get in at the right time (before values move), and you need to exit the investment just before the fall. And, if an investment requires precise market timing to pay off, then it also requires the investor to have a higher appetite for risk.

A good cash flow is definitely an important factor to consider – it keeps you in the market while you wait for growth to occur. However, not just any cash flow property will do – extensive due diligence must also be done to ensure that the higher cash flows do not bring with them the trade-off of higher risk, due to the single industry. It’s highly possible to get good rental yields in great areas with a diverse industry base, a growing population and a high degree of public amenity – you might just need to search a little harder and be sure to avoid the temptation of buying for cash flow alone.