property cents II

Prosper usually looks at macro economics yet a micro example of what can go wrong in the property market – very, very wrong – might aid your concentration.

Andrew, a Sydney ‘investor’ bought properties in Mackay and Blackwater Queensland, “when rents were crazy and out look was bright (sic).”

He posted his entirely credible dilemma on the Somersoft property investor forum.

He paid $495k for a Blackwater rental returning $49,400 pa gross – a hearty 9.9 per cent. Blackwater houses workers at the BMA and Curragh coal mines. With coal prices in the doldrums and layoffs creating plenty of vacancies, agents now value the property at $200k and estimate its rental potential at 18,200 pa gross. The property carries a mortgage of $475k at 4.89 per cent interest or $23,200 pa.

Andrew’s other property in Mackay cost $485k for a passing rent of $36,400 pa, or 7.5 per cent. Now, it is worth $380k and market rents are around $10,400 pa gross. The property carries a mortgage of $450k at 4.89 per cent interest or $22,000 pa.

Violent re-pricing indeed.

Rule of thumb says direct costs, rates, land tax, etc, would be half the gross, certainly on the later rents. So his net rents of around $29,000 support an interest cost of $45,200 pa, or a net loss of $16,200 pa, assuming nil vacancies.

Clearly unhappy with his position, Andrew wants out. He faces a loss of $70k on the Mackay property and $300k on Blackwater if he sells. I suspect these figures disregard Stamp Duty and other transaction costs.

He says, “I have a house in Sydney that has about $500k equity. My mum lives with my family who has contributed into this purchase so selling this property is not an option.”

That equity isn’t his to risk in support of his rental investments. Mum and family would be unimpressed with the idea of selling Baulkum Hills for a Queensland adventure.

“Will this get worse???” he asks plaintively.

His horror story is being repeated all over Queensland and Western Australia. Goaded into action by an army of spruikers in an anecdote-rich, fact-poor media, a naive investor class saw stellar yields and paid a seemingly reasonable capitalization. He thought he won the lottery, when in fact the winner was the vendor.

Little can be done for Andrew and his very hard life lesson.

Yet there is an insight available in what government can do in a volatile land market.

Andrew pays State Land Tax on both Queensland rentals. Valuations are conducted every two years, which softens his liability on the way up but doesn’t retreat nearly quickly enough in a falling market. In an era of wild land price gyrations, government should step up to annual valuations, both to moderate the rise and ease the fall. While this sounds like I am recommending annual revaluation of every parcel of land in the country, it is entirely possible to value half each year and interpolate the rest. SLT already piggy-backs on council valuations, so this is a cost-less exercise.

Land tax is a powerful automatic stabiliser, if we use it properly.

The investor frenzy in Sydney would be less if their bidding up of land prices was immediately transmitted into higher SLT. Dizzy buyers would get a good kicking from existing owners for driving up their costs, rather than the slap on the back for increasing values.