Why Las Vegas?
Live where you like but invest where you can make money.
Las Vegas is a place where you can make money, today and into the foreseeable future. It is a long term hold. Could you make a higher return initially in other locations? Absolutely. However, these locations are typically static or declining and may not be suitable for long term hold.
Metrics such as ROI and cash flow are the most common metrics used to evaluate an investment. However, both ROI and cash flow have a serious limitation: they only tell you how a property will likely perform today, not in the future. Since most investors hold investments for many years, what occurs in the future is actually more important than today. How a property is likely to perform over the long term is largely a function of the local market direction.
Declining vs. Appreciating Markets
Real estate markets change very slowly and what has occurred in the last few years is a good indicator of what is likely to happen in the foreseeable future.
Some characteristics of a distressed location include:
- Relatively low property prices
- Static or declining property prices
- Relatively high return
- Static or declining population
- Static or declining job quality and quantity
Declining markets tend to have a higher than average return in the short term because prices are driven by declining demand. There is a strong correlation between property prices and rent. Rents lag property prices by 2 to 10 years, depending on the specific location. So, in a declining market, the rent you see today reflects property prices from 2 to 10 years ago. See the image below, which compares a declining market and an appreciating market.
In such markets property prices and rents decrease (inflation adjusted) over time. However, declining rents are not the only problem. As the area declines so will tenant quality which means more damage, evictions, skips, vacancies and vandalism.
Once you own a property in such a market there is no easy exit. As property prices continue to decline, you will not be able to sell the property for what you paid for it. In addition, even if you are willing to sell at a loss, the only people willing to buy in a distressed area generally do not have sufficient credit to get a mortgage.
So, while ROI and cash flow make investing in a static or declining market look good, if you plan on holding onto the property you will not do as well as the initial ROI and cash flow indicate.
While in an appreciating market property prices tend to be higher and initial returns lower, if you're holding the property for many years, you will come out much better than a declining market.
As rents increase your return rises because your single biggest expense, debt service, is fixed. Your tenant quality is likely to stay constant or improve so your operating costs are likely to stay the same. While taxes and insurance may increase, neither are usually a significant cost factor. Simplistically, the longer you hold the property in an appreciating market the better you will do. Additionally, as the property appreciates you accumulate equity, which gives you more options. When you choose, you can now sell at a profit or use a 1031 to reinvest equity or adapt to market changes. The big downside to an appreciating market is the lower initial return.
What about the impact of a major recession (like 2008)? The people who occupy C class properties are lower income earners, who were the hardest hit by the recession. The result was extremely high vacancy rates in C class properties. Investors ended up short selling, deeding back to the bank or suffering foreclosure.
A class properties had zero decrease in rent and zero increase in time to rent. (2 min read) While the market value of all properties dropped by 50% or 60% , A class properties returns did not decrease. Note that while rents did not decline, they did not start increasing again until 2013.
There is no way you can protect yourself from a crash in property values, like what occurred in 2008. What you can do is to target a tenant pool who is very likely to stay employed even through a crash. If you are targeting low income earners, as you do with C class properties, when the next crash occurs you could be devastated since low income workers are the first to be laid off and the last to be hired back.
Las Vegas Is An Appreciating Market
Las Vegas has been and continues to be in the state of rapid appreciation.
All the charts cover a 12 months and only include resale of single family homes -
Median Sales Price
Months of Supply. A 6-month supply is considered balanced.
Some interesting articles:
- LinkedIn Workforce Report - Migration - Las Vegas is #5. Employment - 20% increase in employment in the last two years.
- Las Vegas Now the Nation's Hottest Housing Market
- Las Vegas may be the best city to retire in the US
- New large data center - possibly for Google
- Amazon adding 1,000 jobs
- US Housing Market Predictions Real Estate Market Forecast 2018 2019
Big projects (which have or will create thousands of short term and long term jobs):
Drew Las Vegas -$3B
Raider's Stadium -$2B
The 2018 tax reform will impact people living in the high-cost areas of California very hard. A percentage of these people will have no choice but to move to a lower cost location.
To put the numbers in perspective I will look at one small population segment: retired people living in California. There are currently about 6 million retired people in California. If 0.25% of these people chose to move to Las Vegas, you would need at least another 7,500 residences. Since total sales of residences in Las Vegas in 2017 was about 35,000, adding demand for an additional 7,500 residences will result in significant rent and price increases.
Businesses in California are affected by the tax reform too. The limitation on deducting state taxes will increase their operating overhead significantly. Some percentage will be forced to move to a lower cost location. Nevada has no state income taxes and low property taxes. Also, commercial power in California is running over $.17 per kilowatt hour while in Las Vegas it's $.08 per kilowatt hour.
The big drivers are the low cost of land, energy, and proximity to California. Another big factor is the East-West fiber-optic backbone that runs under the Las Vegas Blvd. Many tech infrastructure organizations will be moved out of California to remain competitive. The result will be increased demand for housing which will drive up rents and prices.
Las Vegas Advantages
It is not how much money you make, it's how much money you get to keep.
In Las Vegas, you get to keep more of the money you make because of the low cost of doing business. And, due to a combination of factors, properties are very likely to appreciate and good properties today are very likely to remain good properties in the future.
Good investment properties meet the following three criteria:
- Sustained profitability - The property must generate a positive cash flow today and into the foreseeable future.
- Likely to appreciate over time - Properties appreciate in locations that have increasing demand, which the key driver for sustained profitability.
- Located in an area where you can make money and business risks are low. Only in such an environment can you achieve both current and long term profitability.
As long as you buy property in a good location, all but the worst mistakes will be corrected over time through appreciation, inflation, and rent increases. Said another way, if you buy in a bad location, there is almost no way to recover. What are the factors that make a location "good" or "bad"? Below are some of the most common factors to consider.
- Population stability
- Job quality and job quantity
- Urban sprawl
- Business environment
- Operating cost
Population stability is critical because if people are moving out of an area, housing prices and rental rates are likely to fall due to decreasing demand. If people are moving into an area, housing prices and rental rates are likely to rise due to increasing demand. Las Vegas population is expected to grow by 1.8% to 3% per year into the foreseeable future. This rate is excellent sustainable growth.
Job Quality And Job Quantity
In many parts of the US, manufacturing and similar jobs are being replaced by service sector jobs that tend to pay less than manufacturing jobs. Families of these workers have less disposable income, which means they cannot afford to pay the level of rent they did in the past. A declining per capita income will indicate falling housing prices and rents because the residents can no longer afford to pay what they did in the past.
In 2016, the number of jobs in Las Vegas exceeded pre-crash levels with 50,000 fewer construction jobs. Most construction jobs are transient, so the fact that there are more jobs today than at the pre-crash peak with fewer construction jobs is great news. Also, according to the federal reserve, per-capita incomes continue to rise.
Urban sprawl is a major factor to consider. Areas that were once the best places to live, over time become distressed. This is because people want newer floor plans, newer homes, less crime, better schools, etc. If people have the income, they will choose to move to a location that better meets their current needs. As people with higher income move out of an area, those left behind will, on average, have lower incomes. One result of the outward migration of people with income is that property prices (and rents) will tend to fall because the remaining residents have less disposable income. As property prices fall, property tax revenues will fall. City services, which primarily depend on tax revenues, will be reduced. This creates a downward spiral from which few locations ever recover. Below is a gif of the Las Vegas valley which shows the growth between 1984 and 2016. The green areas are federal land. 2017-2018 saw tremendous growth for Las Vegas so there is even less land than what is shown in the gif.
The Las Vegas valley is almost entirely built out of the federal land boundary. In the future, Las Vegas' only growth path will be redevelopment. This means that A class property you buy today is very likely to stay A class properties in the long term because there is no place else to develop.
Very few cities have such a limitation to expansion. Click on the various cities below and see the effects of urban sprawl where there are no limits to expansion. As an investor in such sprawling cities, you will likely need to sell your property every few years and repurchase further out of the current class A areas.
It is very hard to consistently make money in business climates with many and difficult state and local government regulation. One of the easiest ways to determine the business environment for a location is the cost and time to evict. In some states, it can take up to one year and cost thousands to evict a non-performing tenant. In Las Vegas, the time to evict is usually less than 28 days and costs less tha $500.
Another warning sign is rent control. Over time, rent control can turn good investments into money pits. There is no such thing as rent control in Nevada.
Overhead costs - A good example is a cost for a permit. In Austin TX, the permit to replace a water heater is $450. In Las Vegas, the cost for the same permit is $60.
Two other easy methods to evaluate the cost of doing business in a particular location are to consider property taxes and insurance cost.
- Property taxes - A friend in Austin, TX is paying 2.5% property taxes. The average in Las Vegas is about 0.55%. Property taxes are a direct hit on your bottom line.
- Low Insurance cost - landlord insurance in Austin is close to $2,000/Yr for a typical 2,000SqFt single family home ($350,000+) vs. about $450/Yr. for a typical 2,000 single family home (< $250,000) in Las Vegas. This is another direct hit on the bottom line.
Debt service, taxes, insurance, and management are relatively fixed costs. The wildcards are vacancy and maintenance cost. Maintenance costs can be very different from one location to another but are a continual drag on profitability. Below are some generalizations about maintenance costs:
- Older properties require more maintenance than newer properties.
- Composition roofs require more maintenance than tile or metal roofs.
- Properties in climates with hard freezes require more maintenance than properties in milder climates.
- Properties in locations with a lot of moisture require more maintenance than properties in dryer climates.
- Wood siding requires more maintenance than aluminum, vinyl or stucco siding.
- Properties with lush vegetation require more maintenance than properties with little or no vegetation.
Below is a typical Las Vegas single-family class A home. As you can see, there is not a lot to maintain.
It's not how much money you make, it's how much money you get to keep. In Las Vegas, you get to keep more of the money you make because of the overall business-friendly environment and the low cost of doing business. And, with the continued population growth, economic expansion, rising per-capita income, and no urban sprawl, your properties are very likely to increase in value over time.