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as Vegas is battling the economic recession on two fronts — a local housing market in disarray and the first-ever yearly decline in tourism. Both call into question whether widespread speculative development in Las Vegas will ever be the jackpot it had been.
Steve Wynn, the legendary casino magnate, recently admitted in a 60 Minutes interview that if he had known that the economy would have turned down so significantly, he would not have started his latest casino resort, Encore. Of course, he added that developments like Encore take many years to come to fruition and the signs of economic distress were not evident when the project was being planned four years ago.
Not surprisingly, the hubris that characterized the overall economy in recent years was especially evident in Las Vegas.
No single project embodies this mix of optimism and gambling spirit like MGM Mirage's ambitious CityCenter. Conceived as the U.S. economy hit its peak, the 16 million square foot development in the heart of "The Strip," includes 5,000 rooms spanning three hotels, a casino, shopping mall, and 2,700 condominium units in two towers. Development costs were a staggering $7.5 billion. Overruns and construction problems have pushed that number to $8.6 billion. Today, disagreements between its investors and financing challenges have stalled progress. Even though MGM recently paid contractors $70 million to keep them on the job, the real possibility of an MGM Mirage bankruptcy due to the $13 billion in debt it has amassed puts completion in jeopardy.
Even considered large by Las Vegas standards, CityCenter is simply the latest in a long line of "all in" bets by developers, who for more than three decades have gambled successfully on the town's unprecedented and consistent growth. Based on that track record, it is easy to see why rampant speculation enjoyed so little scrutiny by bankers, developers, investors, and retailers.
The accompanying map of the strip lays out some of the recent projects that have fueled the large-scale condominium development boom over the last few years.
Tourism — A Steady Driver
Anecdotal stories abound that ‘no one is gambling,' ‘tourism has tanked', and that ‘hotels are giving away rooms.'
While grounded in some fact, these observations do not paint the complete picture. At least through the end of 2008, Las Vegas tourism remained strong. To put the situation into clearer perspective, 37.5 million visitors came to Las Vegas in 2008. Although off its 2007 peak, Las Vegas remained one of the most popular tourist destinations in the world. These visitors were also still spending in the casinos as evidenced by 2008 gross gaming revenues of $9.8 billion — just $1.1 billion shy of the 2007 peak. For the majority of 2008, hotel occupancy remained strong, underscoring a market whose economic engine remained well-primed when many other parts of the country witnessed unprecedented decline. The accompanying charts highlight these long term growth trends in tourism and gaming revenues.
The first part of 2009 shows that there has been some recent slippage in these year-end numbers. As of February, total visitors are down 10% and gaming revenues have declined 17%. Hotel occupancy also declined to 81.5% versus 90.6% the pervious year.
The problem today is that the region's unchecked optimism has created a serious disconnect between Las Vegas' monolithic plans and the realities of a slowing economy. In the past, the city was continually re-invented through the development of these large-scale projects — which spurred further tourist gains as visitors flocked to the area to see the new sights.
During these times, the worst that ever happened was that too many rooms and casinos were added. Demand, however, always quickly grew to accommodate the new rooms and Las Vegas' life blood, gaming revenues, never really showed any decline. For example, while national travel patterns dropped precipitously after the terrorist attacks of 9/11 and the tech bust — Las Vegas visitation, occupied room nights, and gaming revenues all grew.
This Time is Different — A War on Two Fronts
The slowing visitor market — Las Vegas' principal economic engine — is moving negative for essentially the first time in 40 years. This is happening at a time when 8,700 hotel rooms came on-line in 2008, with another 18,000 rooms poised to be added by 2010.
In the past, the Las Vegas economy functioned relatively independently because its drivers — tourism and gaming — were unique and insulated from other parts of the macro economy. In some ways, it could have been called recession proof. This time, however, the far-reaching effects of the housing bust have linked Las Vegas to the broader economy — significantly impacting its domestic and international customer base.
The Local Housing Bust
What led Las Vegas into the slowdown was the extreme speculation in housing — not unlike the speculation on the gaming front. Las Vegas is, unfortunately, a case study for many of the most troubled markets across the U.S. As such, Las Vegas' current economic downturn is related not only to its own housing bust, but to the national and global repercussions.
It is important to remember that Las Vegas was one of the first markets to show extreme weakness in the housing market — evident as early as 2006. In a nutshell, speculators came into the market to make a fast buck. The home flipping strategy they employed drove prices up (in what had been a very affordable market). Their investment activity also created housing demand that was unreal and unsustainable.
The National Association of Realtors (NAR) reported that the median home price in Las Vegas rose from $132,000 in 2000 to $321,000 by mid-year 2006. This equates to an annual appreciation rate of 15%. Today, NAR estimates that the median home price has fallen to $183,000 — an extraordinary decline of 43% from its peak.
What is, perhaps, even more dramatic is the level of overbuilding that took place. While a variety of methodologies exist to estimate home demand, we looked at the relationship between residential permit activity and employment growth. Quite simply — new jobs create demand for new homes.
In looking back, Las Vegas clearly shows a boom-bust cycle in home construction since the 1980s. As in many markets, home building periodically gets ahead of demand and then slows to fall back into balance.
For example, looking at the economic expansion of 1993–2000, the region generated 214,500 building permits and added 309,000 jobs. This translates into a ratio of one new building permit for every 1.44 jobs.
In comparison, between 2000 and 2007 the region issued 256,100 housing permits on a base of 266,000 new jobs a ratio of almost one permit for every one job. This recent one-to-one ratio was clearly not supported by real housing demand, but rather by extensive speculation from outside the market. Assuming the 1993–2000 ratio of one permit for every 1.44 jobs is about right for the market, Las Vegas was overbuilt between 2000 and 2007 by as many as 100,000 homes.
Magnitude of the Distress
RealtyTrac reports on home foreclosures nationally. Their data shows that as of first quarter Las Vegas ranked at the top of U.S. metro areas, with over 35,000 foreclosure filings. This equates to almost 4.5%, seven times higher than the U.S. average.
As could be expected, the top 10 zip codes with foreclosures in Las Vegas were in the expanding suburbs to the northwest, southwest, and southeast parts of the metro area. (See accompanying map.) For example, the top ranked zip code (89108) is located in north Las Vegas and has had over 2,200 homes fall into foreclosure since January 2008. Currently, the median existing home value is $132,000 — down 32% in the last year.
Retail has been especially hard hit by the downturn; particularly so in the greater Las Vegas area. Although the pullback in consumer spending is to blame nationally — the over-speculation in Las Vegas housing has exacerbated the problem because retail tends to follow the rooftops. Many Las Vegas homes were purchased by investors who hoped for a quick flip. As such, many were never occupied or occupied only for a short period as the investor moved on to other speculative properties or walked away from a losing bet.
In this way, the driver of retail demand — new households and their shopping needs — became uncoupled from normal market dynamics.
Troubled shopping centers can be difficult to identify. While percent leased or occupied is easy to track, it is more difficult to uncover centers or retailers within a center that are under-performing or have an unprofitable rent to sales ratio.
Recognizing these issues, Madison Marquette analyzed CoStar data and found that Las Vegas is at the top of our list for potentially distressed retail assets, just behind Phoenix. We have included our list of the markets most likely to see distress on the right.
Our market review underscored that the principal drivers that put Las Vegas in this position were the sudden increase in vacancy during 2008 — when the market moved from 4.7% at the end of 2007 to 7.6% by the end of last year. At the end of the first quarter, this rate increased to 9.3%. In addition, although Las Vegas experienced good net absorption during the period, 7.8 million square feet of space had been delivered or was under construction. Importantly, this continued development was taking place in a market with weak demand fundamentals — as evidenced by a low pre-lease rate in the space under construction.
At this time, a closer look at property-level data shows that much of the disconnect has occurred in the smaller centers. Based on our review, there are 64 centers in the area (over 50,000 square feet) with occupancies less than 80%. While some of these centers may still be in lease-up, the overall retrenchment of retailers, combined with the tough Las Vegas market suggests that many of these centers are now experiencing stress.
The Future
Many observers speculate that commercial property defaults will be the second shoe to drop in the recession. In Las Vegas, the first shoe, the housing market collapse, was so acute it is easy to understand why investors and developers there are extremely worried.
Earlier bets on Las Vegas' continued growth have always been rewarded. It remains to be seen whether another rescue will come or whether a slowdown in growth is inevitable because there is a limit to the demand for the entertainment capital of the world.
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