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Home | Mises Library | Wake Me When the Real Estate Market Improves

Wake Me When the Real Estate Market Improves

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Tags Booms and BustsFree Markets

02/11/2008Doug French

On a recent Saturday morning, the anesthesiologist looked down at me and said "It's time to give you medicine now." I responded, "Can you put me out until the market gets better in 2009?" Alas, forty-five minutes later, the nurse woke me and told me to leave. My colon evidently is fine; the real estate market in Las Vegas — not so much.

The talking heads on CNBC can debate whether the US economy is currently in a recession, but it sure feels like one here. In fact John Williams' numbers at Shadow Government Statistics indicate the US economy has been in a recession since the 4th quarter of 2004. While the Las Vegas economy has traditionally been resilient to downturns nationally, this isn't your typical downturn and Sin City is suffering.

Clark County's (Nevada) unemployment rate in December was 5.6% and according to UNLV's Center for Business and Economic Research, only 7,700 new jobs were created last year. And while over 6,000 people a month move to town, just about as many have been leaving, given that the active residential electrical meter count increased by just over 14,000 in 2007. Jobs are so scarce in Las Vegas that 7-Eleven was even able to hire a grown man to stand on a sidewalk dressed up as a Slurpie to promote one of its new stores.

Jeremy Aguaro told the Preview Las Vegas crowd that job growth will likely turn negative this year. And it's not just construction jobs being lost; the largest job category for new unemployment claims is professional business services.

Even gaming revenue hit the ditch in November dropping 14%, the largest single month drop in five years, with the LV Strip fairing even worse with a 20% drop in gaming revenues.

Of course everyone knows the residential market is in the tank, with less than 20,000 new homes closed in 2007, down 45% from 2006. Prices have even fallen by 9 percent for new homes (much more considering builder incentives). But builders are getting the message, or going broke. There were only 235 permits pulled in December after only 305 were pulled in November. And large national homebuilder Engle Homes filed for bankruptcy in January, with others like Kimble Hill rumored to be close to it.

Even the developer of the lavish master-planned community Lake Las Vegas defaulted on a $560 million loan. A group of creditors took over ownership of the Henderson luxury master-planned community and in turn sold it to a turnaround firm.

Plus, Nevada had the highest foreclosure rate in the nation last year, with 3.4 percent of its households filing for foreclosure, more than three times the national average, according to RealtyTrac. The Las Vegas valley even has the dubious distinction of having seven of the 100 worst-hit ZIP codes in the country for foreclosures in December.

Even big realtors haven't been immune. Mark Stark bought Prudential Americana Group Las Vegas in 2004 by borrowing $22.5 million to outbid Warren Buffett's HomeServices of America for the company. He never envisioned the Las Vegas housing market tanking like it did and filed Chapter 11 last November.

As In Business Las Vegas reports, Stark's firm went from an administrative staff of 118 at the height of the market two years ago to 78 today. The number of agents has been trimmed from 1,500 to 1,200, with Prudential shedding 25 to 30 agents a month, a trend that is expected to continue in 2008.

Those who work in the real estate industry are not the only ones feeling the pain. Focus Property Group, the same company that bid up the price and ultimately spent nearly $1.3 billion buying most of the large land parcels auctioned by the Las Vegas Bureau of Land Management (BLM) in the last few years, announced that it has stopped making interest payments on $500 million in loans secured by 4,800 acres in the Las Vegas Valley, Pahrump and Victorville, Calif.

Focus is asking for forbearance on the half a billion dollars in loans so that it will not be required to make interest payments, possibly for two years, reports the Las Vegas Review Journal. These loans were made by private lenders, pooling dollars from individual investors, with the average rate on these loans being 11 percent according to Focus CEO John Ritter. It's easy to speculate that everyone from little old ladies to big casino fat cats has money lent to Focus. The 11 percent was good while it lasted.

Of course the company is ostensibly in the business of developing master-planned communities and selling parcels to homebuilders and commercial developers. But as Focus COO Tom DeVore told the R-J, "We haven't sold a piece of single-family residential (land) since early 2005."

There has been an explosion in the number of private lenders in Las Vegas since the credit crunch of the early 1990's when banks were reluctant to lend despite a vibrant Las Vegas real estate market at the time. The loose monetary policies of the Federal Reserve has also sent savers to higher yielding investments as it lowered rates and gunned the money supply in anticipation of a Y2K economic meltdown and in reaction to 9/11 and the current mortgage malaise.

But the private lending industry has been plagued with fraud and mismanagement, with a number of individuals losing all or part of their life savings in pursuit of earning double-digit returns.

One of the largest of these private lenders was USA Capital that made loans to developers and then would service the loans. An affiliate company USA Investment Partners was set up because the owners of USA Capital saw their developer customers getting rich in the boom and wanted to share in those riches, so they told would-be borrowers: "If you give me 50 percent of that deal, I will arrange for you to get a loan," according to USA Bankruptcy Trustee Lisa Poulin.

USA Capital had 6,000 investors when the company filed for bankruptcy in 2006.

The housing market is so bad that Donald Trump had a full page ad in the Las Vegas Review-Journal recently advertising his Trump University where you can learn how to "Buy Low, Sell High, Walk Away Rich" by "rid[ing] the recent tidal wave of real estate foreclosures."

But this year is not projected to be any better than last year. "The bottom line for 2008 is hopefully 'flat and steady', which will be an improvement over 'continues downward,'" Dennis Smith writes in his Las Vegas Housing Market Letter. "Things should be looking much better as we enter 2009, and even better by 2010."

Home marketing guru Steve Bottfeld has a sunnier view believing sales will increase in 2008 by 25% for new homes and 45% for resales with new home prices increasing 8% and resale prices increasing 10%.

Bottfeld says there will be another Las Vegas housing boom by 2010.

So while housing finds a bottom in Las Vegas, what is happening in the commercial real estate market? With housing down, development dollars rushed into commercial projects. There has never been as many dollars of permitted commercial real estate projects in Las Vegas as there were in 2007, numbers man Jeremy Aguaro told the Preview Las Vegas crowd. But this overbuilding is starting to show.

Restrepo Consulting Group (RCG), reports that vacancy rates are increasing and average rents are falling for industrial, office and retail space. RCG estimates that it will take over three years to absorb the standing and planned industrial space, nearly four years to absorb the standing and planned office space and over a year and a half to absorb the available and planned retail space.

But the stress on income properties hasn't made news yet. Ironically, in the same edition of the R-J that The Donald was advertising his class on how to get rich in residential foreclosures, Cherif Medawar had a full-page ad only seven pages after Trump's trumpeting "How You Can Get Super Rich with Las Vegas' Commercial Real Estate!" The ad says Mr. Medawar went "From Hotel Manager to Real Estate Magnate" and "Anyone Can Do It!"

There is no question that Las Vegas is a special city. It has a brand name second only to Google's in recognition. And what other place could host the crowning of Kirsten Haglund as Miss America, Penny Flame as the Adult Video News' Best Actress, Garrett Hood as the world's best bricklayer, and Erika Jensen as the National Grocers Association USA's Best Bagger, all during the few weeks since the first of this year.

John Restrepo of RCG is optimistic for the future of Las Vegas, projecting that the Clark County population will grow by half a million people between now and 2012, with the number of new jobs growing by 200,000 over the next five years. This job and population growth will be driven by close to $67 billion being invested in new projects on the Strip between now and 2012.

But what happens between now and then?

Marc Faber told the Barron's roundtable: "At the moment, there is a war: The private sector is cutting credit and the central banks are cutting interest rates because they are desperate to revitalize credit growth. In the long run, the central banks will win, but in the next six to 12 months, relative credit contraction isn't going to be good for any asset class."

Wells Fargo economist Scott Anderson echoes this view; "Large money-center banks have virtually frozen their balance sheets, reluctant to lend even to good credit."

"Comptroller of the Currency John Dugan urged bankers [recently] to take proactive steps — or face harsh treatment from examiners," reports The American Banker.

"For those of you in stressed markets," Dugan said "it will almost certainly require you to downgrade more of your assets, increase loan-loss provisions, and reassess the adequacy of bank capital."

Former Comptroller Eugene Ludwig commented at a dinner in New York early this year that he expects serious damage to the banking sector this year and he considers today's credit problems much worse than what was experienced in 1989 and 1990, with no bank immune. Even strong loan portfolios will suffer according to Ludwig.

The ex-Comptroller expects a major credit contraction that will be further aggravated during the next bank examination cycle, with field examiners unrestrained, as was the case in 1989 and 1990.

So while the terminally bullish Las Vegas real estate expert Richard Lee is glad last year is gone and that 2007 was the worst real estate market he has ever seen, the worst of it may be ahead for Las Vegas bankers when examiners darken their doors this year.

Lee was not the least bit optimistic during his presentation that closed Preview. He cautioned that, "my crystal ball is cloudy," and "we can't outguess the market." Proving that there is nothing new going on in Las Vegas, Lee didn't really have anything to report, and resorted to providing this one juicy bit of advice: "Sell low, buy low!"

Of course Mr. Lee was talking about Las Vegas real estate. But maybe he should have been talking about bank and gold-mining stocks. Bank stock prices have been beaten up worse than home prices. In fact, short interest in bank stocks, especially those located in western states, continues to grow, despite the average bank share price being down 38 percent from a year ago.

And anyone holding gold-mining stocks has noticed that mining shares have not kept pace with the price of the yellow metal. The Global Gold Index shows that gold shares, as a whole, have not yet traded above their May-2006 peak and the GGI is about 13% below that level, according to Steve Saville at speculative-investor.com.

David Galland, Managing Director of Casey Research asked one of the Casey researchers to review gold price and gold share price histories to determine at "what price level gold needs to reach before we would, based on historical precedence, start seeing serious movement in the gold stocks." Galland writes that nothing is definitive yet, but the initial guess is $1,000 per ounce gold is what it will take to get the mainstream investing public interested in gold stocks.

But the dozens of high-rise cranes dotting the skyline reminds us that better days are ahead for Las Vegas – a city that sells hopes, dreams and fantasy. Up until now, it's been the tourists that routinely got their wallets emptied, but had good times to show for it. Now, some of the locals are feeling the pain as lady luck, bad math and bad judgment are punishing them. Oh well, at least I have my health.

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