Las Vegas strip luxury condo market... when to buy?

[DespotInExile]

Sort of an off-topic investment thesis, but have any of you considered whether to step into the Las Vegas strip luxury condo market? Some distressed sales are appearing on the MGM Signature property, and a large supply overhang will come online in 2009 through the CityCenter project. I was thinking of setting up a fractional LLC with some friends to purchase a luxury strip condo. The only question is timing. Thoughts?

[stephenNUTS]

IMO buying a LUXERY condo on the LV strip would be HIGHLY speculative at this time.Condominium sales(esp. in overbuilt UNSOLD markets) ALWAYS trail in value vs. home sales in a weak R/E market for many different reasons

I know from my own personal experience back in the early 1990's R/E market downturn [img]/images/graemlins/frown.gif[/img]

[CrushinFelt]

Just as Good2CU he just bought one I believe.

[pig4bill]

Wait a year.

[DesertCat]

What is their price to rent ratio? Absent that my guess is about five years before the decline is over.

[spex x]

IMO a strategy of trying to time the upswing of a RE market is very risky and speculative. I wouldn't do what you're suggesting at all. Why focus on luxury strip condos as RE investments? As good or better of returns can be made in lots of other RE types without nearly as much risk.

[Mook]

[ QUOTE ]
Some distressed sales are appearing on the MGM Signature property, and a large supply overhang will come online in 2009 through the CityCenter project.

[/ QUOTE ]
Umm ... haven't you more or less answered your own question here?

Start of large supply overhang + time to work through said overhang at average rate of sales = earliest you should think about buying.

I suspect DesertCat's estimate is at least in the ballpark.

[DespotInExile]

[ QUOTE ]
[ QUOTE ]
Some distressed sales are appearing on the MGM Signature property, and a large supply overhang will come online in 2009 through the CityCenter project.

[/ QUOTE ]
Umm ... haven't you more or less answered your own question here?

Start of large supply overhang + time to work through said overhang at average rate of sales = earliest you should think about buying.

I suspect DesertCat's estimate is at least in the ballpark.

[/ QUOTE ]

I found this website which does a good job of summarizing the coming strip/near-strip condo supply that is coming on line. I count at least 9 projects, plus other condos further off strip and downtown.

I dont think Desert Cat's price:rent ratio is exactly right, since rental and ownership aren't perfect substitutes for each other due to tax distortions, premiums that people voluntarily pay for ownership, etc.

OTOH, if you believe Vegas strip is primarily an investment/second home market, then maybe Desert Cat's point is more true. 5 years seems too long, I'm thinking more like 12-18 months, but I could be way off base here.

[DesertCat]

[ QUOTE ]


I dont think Desert Cat's price:rent ratio is exactly right, since rental and ownership aren't perfect substitutes for each other due to tax distortions, premiums that people voluntarily pay for ownership, etc.

OTOH, if you believe Vegas strip is primarily an investment/second home market, then maybe Desert Cat's point is more true. 5 years seems too long, I'm thinking more like 12-18 months, but I could be way off base here.

[/ QUOTE ]

There is a lot of tax arbitrage that goes on with Vegas condos, i.e. people declare Nevada their state of residence so they can avoid their home state's income taxes. California is very aggressive about catching these people, but not so much other states. So I'd say a lot of these units are second homes.

And clearly rental and ownership aren't perfect substitutes, but they are very close when you are talking about houses, and even closer when you are talking about condos. And a big part of the premium paid for ownership is the assumption of appreciation. That premium was at all time high levels a year or two ago. What do you think it will be like if we have 5 years of price declines? Homes may starting having ownership discounts due to the assumption of further declines.

That said it's easy to compare the raw costs of ownership vs. renting, your wild card will be your appreciation assumptions. Assume you can rent a $1M condo for $4,000 (from a luxury home I looked at recently in North Scottsdale). Your cost of renting is $48,000 per year, or about 5.4% of the purchase price.

To buy the condo, let's assume you get a 6% mortgage for $800k, and use $200k you had in a bond fund that also was earning 6% per year. You are in the 33% tax bracket. So your net financing cost is 4% a year on the $1M, or $40,000, since you are able to deduct 2% of your mortgage interest against your taxes, and you were only earning 4% after tax on your down payment. So your costs are about $40,000 per year. You also need to add net property taxes (after tax deductions), maintenance, home owner fees, and insurance. If those costs are are $20,000 per year, your direct costs of ownership are $12,000 per year more than owning.

So net appreciation has to make up for that $12k per year. Let's assume you sell the unit for $1.1M in five years. You'll probably have to pay a realtor 6%, so you're net gain is $40,000. But you put $60,000 into it, hence it not only cost you money, but it also handcuffed you into a deal with negative optionality. If for some reason you are forced to sell it for $1M a year later while the market is still soft, you lose $72,000 in a single year of residence.

And I think I'm actually being somewhat optomistic. W

hat if you can earn more than 6% a year from your down payment, i.e in the stock market at 8% or so?

What if your mortgage is at 7%?

If you can afford such an expensive unit, you are highly likely to be in AMT territory, what if you can only deduct half of your interest on your taxes because of AMT?

And what if prices are lower in five years and it's only worth $900k? Your paper loss will be about $160,000.

But if you can rent the unit for the same amount it costs to own, suddenly your sale price matters much less. You don't have to make up any extra costs when you sell it, so you only need 6% appreciation to break even.

And if you can rent it for more than your ownership costs, then who cares what the market does? You are making positive cash flow every year, and you can just wait until it appreciates to a level where selling is far more profitable than holding.

If you want to be a real estate investor, you should understand all of these issues and you need to make these kind of estimates to understand what kind of price you will be paying.

Lastly, anyone considering buying real estate should should read this article from Fortune. Note that a couple of risks that the article doesn't really cover are, falling rents from flippers trying to save their investments by dumping tons of new units onto the rental markets, and higher interest rates, which would drive down the value of real estate because it increases costs of ownership.

For years realtors have been extolling real estate as a great investment, and they've been right because real estae benefited from a tail wind of gradually lower interest rates since the late 1970s that helped increase it's value. We no longer have that tail wind, interest rates aren't likely to go lower and could go higher. And appreciation became a self fulfilling prophecy for a while, it created a mass of speculative buyers flipping homes and driving prices up. Home owners built far too many homes for the true demand of owners, and now the speculators are dumping their investments and no longer buying. If you do the math you realize the median home can't appreciate faster than the median income (4-5% per year), or pretty quickly homes would be come unaffordable and no one would buy them.

We have a lot of catching up to do to get that long term price trend line back where incomes are, and it could end up being incrediably brutal.