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The Land-Price Bubble

June 10, 2003

While the Federal Reserve — induced stock market bubble has been flattened, despite continuous inflating by Greenspan's troops, the land price bubble continues to expand in Las Vegas. Evidence the June 5th auction of a small sliver of the Bureau of Land Management's land horde. The BLM owns approximately 90% of the land in Clark County, Nevada, which includes Las Vegas.

These BLM auctions are held twice a year as a result of the Southern Nevada Public Land Management Act, which became law in October 1998. As people continue to move to the Las Vegas area — the population has tripled since the mid-1980's — getting the federal government to release some of its land has been key to providing housing and commercial services for the influx of people moving to southern Nevada.

Interior Secretary Gail Norton attended last weeks auction, forcing the standing room only audience to endure her politically correct remarks about conservation and education, before the bidding could get underway. It would be cause for celebration if the proceeds of the auction went towards paying down the federal government's debt, or better yet, have the money returned to the taxpayers. But no, the Nevada General Education Fund receives 5% of the auction proceeds, the Southern Nevada Water Authority receives 10%, and the rest goes into to a special account available for the Secretary of the Interior to, guess what, acquire more land. But not just any old land, environmentally sensitive land in Nevada, of course. No wonder Ms. Norton was grinning from ear to ear while she watched as 995 acres were sold for $232,285,000.

The average sales price of $233,452 per acre was a new record for these auctions, eclipsing the record of $159,944 per acre set at last November's auction, a 46% increase. The average price per acre for all the auctions held previous to last week's auction was $85,541.

Parcels as small as one and a quarter acre are sold at these auctions, but the real excitement is generated by the sale of the large land parcels that generate the huge bids. Not many can play at this level, as the BLM requires 20% of the bid price to be paid the day of the auction, while the remaining 80% must be paid within 180 days.

The first large parcel that was auctioned contains 247.75 acres and is located south of town, just west of Interstate Highway 15, which cuts the city in half. Bidding starts at whatever a fee appraiser, hired by the BLM, believes is the fair market value for a particular parcel. In this case, just north of $34 million. Within seconds, the bidding between two builder/developer groups pushed the price to over $50 million, and after plenty of head scratching, huddling and calculator punching the parcel eventually sold for $62.6 million.

The last parcel to be auctioned totals 485 acres and is located in the far northwest corner of the valley. The bidding started at the appraised value of $58.2 million, but didn't stay there long, culminating with a winning bid of 113.5 million inflation-ravaged dollars. The winning bidder, Focus Property Group, was the same group that paid $160 million for 1,000 acres at the November 2002 BLM sale.

Although it looks as if these developers are taking a huge gamble with the purchase of these large land parcels, for the most part they have obtained commitments from homebuilders for the purchase of a large portion of the acreage before the auction.

As Las Vegas has grown, it has attracted the attention of many of the nations large publicly held homebuilders. And, with over 20,000 new homes sold each year in Clark County, these builders are manic about maintaining their respective market shares. To do that, they must have land to build on. This mad scramble for land along with increased permit costs and governmental red tape has forced many small local builders out of the business. Since 1996, seventy-one Las Vegas builders have shut down or sold out.

The top ten builders in Las Vegas sold over half of all the new homes that were sold in the entire valley last year. Replacing that land inventory is getting more and more difficult. Local housing expert, Dennis Smith, publisher of Home Builders Research in Las Vegas, estimates that if the federal government does not make more land available for sale in Clark County, there is only a 13-year supply of land left for residential development.

Home sales are what fuel this land grab. And, with Alan Greenspan's foot tromped on the monetary accelerator, low mortgage rates are allowing more people to buy bigger houses. In April, the median price of a new home in Las Vegas rose to just an eyelash below $200,000, a doubling in less than 14 years. Plus, this spring's new homes were most likely built on land purchased two years ago or more, for a fraction of what land is now selling for.

Reporting on the November 2002 Las Vegas BLM auction, Patrick Barta wrote in the Wall Street Journal that, "home prices have climbed 27% [in Las Vegas] since 1999, nearly seven times as fast as the growth in household incomes in the city. Many builders and would-be homeowners worry that the land frenzy will turn Las Vegas, long known as a place where casino dealers and cocktail waitresses could afford a piece of the American dream, into just another pocket of expensive real estate."

Even for those of us who have studied the history of past speculative bubbles and how badly they end, it's hard not to be seduced by what seems to be the inevitable increase in land prices. It's easy to forget that just two years ago, at the May 2001 BLM auction, a 1,905-acre parcel was sold for only $47.2 million, $24,672 per acre. At the time, the winner bidder was criticized for paying too much.

But, eventually interest rates will rise, home prices will outstrip the average Las Vegas working stiff's ability to cover the monthly mortgage nut, Nevada's state government will burden businesses with enough taxes to stunt job growth, and these builders — or their lenders — will have more ground than they know what to do with.

A CFO for one of these large builders admitted to me that he was having trouble justifying the purchase of these high-priced land parcels to the brass at his company's out-of-state headquarters. He indicated that assuming today's home prices does not make any of their land purchases economically viable. They must project that home prices will continue to increase at the same rapid rate that they have the past few years for the deals to "pencil." Thus, homebuilders are now becoming land speculators, likely placing undo reliance upon the clarity of their crystal balls.

John Maynard Keynes metaphorically described speculative markets in The General Theory:

Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity.

For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs — a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbor before the game is over, who secures a chair for himself when the music stops.

Although it looks like Alan Greenspan is going to be on the job tending to the printing press for a long time, the BLM shouldn't expect to continue setting land-price records. Eventually the music will stop. However, sanity is not likely to appear in time for the next auction coming this fall. Developers already have their eyes on a prized 1,500-acre parcel located in the southeast part of the valley, with the bidding likely to start at $300 million.


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