Coldwell Banker Premier Realty

Residential Investment in Las Vegas


Yields, why the boom and bust, gaming uptick
Posted: September 21, 2011 by John McClelland

 

One of the reasons that we believe Las Vegas is a good place to acquire properties for a long-term hold is based on fundamental measures such as price-rent ratios and the level of pricing below the longer-term, pre-bubble trend. Currently the price-rent ratio is about 6. In addition, it is often less expensive to buy than it is to rent. Similarly, cap rates are elevated implying an undervalued situation or investor sentiment. I tend to think it is still undervalued even though it is oversupplied. We are starting to see some recent firming up in rents as well. The exhibit below shows rents, cap rates and home prices. You can see that while rents have been pretty stable, the yields have gone up do to asset price declines.
 
Comparatively, when we look at yields, it is very common in Las Vegas to find cap rates in excess of 8%. As property markets tend to roll in long waves, long increases, long declines, I like cash flow and markets that might move back towards a longer-term trend, as in Case-shiller exhibit in this email. When we look at property yields in other domestic markets, we typically don’t see more than 7%. Many other markets are seeing far less, including Hong Kong (2.1 to 3.69%, although it is known as a safe haven) and the Sydney market is about 4.4%. Depending on the cost of capital, I think there is a good case for buying in markets like Las Vegas that were caught in a downdraft of foreclosures but is seeing a flattening in prices.
 
To answer a common question about the level of foreclosures in Las Vegas and Florida, it’s a tough issue to grasp. Steven Shiller, of Case-Shiller fame (known for predicting the housing bubble would pop as well as the U.S equity bubble) noted the roll in storytelling in precipitating bubbles. I tend to agree as I was here in Las Vegas during the boom years and heard a lot of these stories myself. Initially, I think investors and homebuilders were interested in Las Vegas based on fundamentals. This first wave of buyers understood that Las Vegas had intense population and job growth which was sustained for several decades. Around periods of Mega Casino construction, we often saw shortages of some housing types. The casino businesses, along with some ancillary businesses, were booming through the 1990’s and barely experienced a hiccup in the 2001 recession. South Florida had similar growth, though much of it was from retiree, entertainment and international trade. The second part of the equation likely relates to liquidity slushing around trying to find a home. The story was told that home prices rarely go down and default rates in the U.S were very small, I think it was .5% for a sustained period. Easy access to loans, along with storytelling about “this great investment” brought a second wave of inexperienced investors to Las Vegas. I often heard from cab drives, barbers, bartenders and grocery clerks that housing was the way to go. That’s how storytelling amplified the problem. (Shiller gives a good interview in this podcast: http://www.econtalk.org/archives/2008/09/shiller_on_hous.html).
 
As soon as yields shrunk below the cost of capital and owners of mortgage backed securities realized that it doesn’t take that many more defaults than forecasted to cause their investments to decline in value severely, the bubble became more obvious. These investors were the first ones to jump when the market began skidding. Luckily, those days are long-gone. Half of our transactions are closed with Cash and the number of homes with a mortgage declines each consecutive quarter. This bodes well for longer term stability of the market.
 
Meanwhile, gaming and hospitality numbers have been increasingly better, with visitor volume, gaming revenue, hotel occupancy and room rates each showing year-over-year increases and very pronounced inflection points. This ultimately translates into job growth since gaming and hospitality continues to be a core industry, accounting for about 40% of our business, directly and indirectly. Please see the attached gaming exhibits.



 
  Source: LVCVA.

 
   Source: Standard & Poors.

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