Las Vegas

[Victor B.]

Good Evening BP,

I'm going to be taking a trip to Las Vegas to prospect investment properties. I'm looking to purchase a single family property and follow a Buy and Hold strategy. What are some things I should do either prior to or during my trip to get the most out of my time?

[Eric Fernwood]

Hello @Dan Trinh,

I just saw your post and wanted to respond. I choose to cover more than just responding to your specific observation on a specific price range of properties in Las Vegas. Before I continue, know that I am a Realtor in Las Vegas and a member of the Las Vegas Real Estate Investment Group. Here is my profile. Now that you know my potential bias, I will continue.

So we are on the same page, I believe every investment property/location must meet three criteria:

• Sustained profitability - The property must generate an acceptable cash flow today and into the foreseeable future.

• Likely to appreciate over time - You would never buy a property just for appreciation but appreciation is very desirable. Especially when using a 1031 Exchange to reinvest equity or to adapt to market changes.

• Located in an area with acceptable business risk. Many location specific business risks are the result of legislation. For example, if a tenant in California knows what they are doing it can take up to one year (and thousands of dollars) to evict them. In Las Vegas it usually takes less than 30 days and usually costs less than $500.

Note that the above does not specify a location or type of property. What it does specify are the characteristics that a successful investment must have. Assuming that we are now on the same starting point, I want to address your concerns in a more general manner using the following topics.

• Comparing properties in different locations.

• Market changes - The return today is not a predictor of return in the future.

• Las Vegas Real Estate Investments - Looking at Las Vegas from a long term investment perspective.

Comparing Properties In Different Locations

I've seen many methods of calculating ROI and cash flow. And, as long as you are comparing similar properties in close proximity, most methods will work. However, if you are comparing properties in different locations, you need to compare all the major common recurring costs, which may be different depending on the location. I will use the three most common recurring costs in my explanations in this section.

The formula we use to calculate ROI is as follows:

While there could be dramatic differences in factors like maintenance, vacancy rates and such, I will keep it simple and only show the impact of variations in state income tax, property tax and insurance.

Below are details on the example property I will use:

• Purchase price $150,000

• Rent: $1,000/Mo. or $12,000/Yr.

• Financing: 20% down, 4.5% interest, 30 year term. Resulting debt service is $608/Mo. or $7,296/Yr.

• Down payment amount: $30,000

• Periodic fees: $0 (for simplicity)

• Management fee: 8% or $12,000/Yr. x 8% = $960/Yr.

• Rehab cost: $0 (for simplicity)

• Closing cost: 0% (for simplicity)

Below are the three locations with the recurring costs for state income tax, property tax and insurance for the respective locations. Below the table are the sources for the location specific data.

Data sources for the above:

• State Income Tax Rate

• Property Tax by County

• Insurance by State - Note: I was unable to find a single site that compared landlord insurance cost by state so I used homeowner's insurance which is reasonable for comparison purposes. Landlord insurance is typically 10% to 20% more than homeowner's insurance.

Below are calculations for the example property in the three locations:

Austin: ROI = (($12,000 - $7,296 - $960 - $1,625 - 1.9% x $150,000 - $0) x (1 - 0%))/($30,000 + $0 + $0) = -2.4%

Indianapolis: ROI = (($12,000 - $7,296 - $960 - $802 - 1.07% x $150,000 - $0) x (1 - 3.4%))/($30,000 + $0 + $0) = 4.3%

Las Vegas: ROI = ($12,000 - $7,296 - $960 - $710 - 1.07% x $150,000 - $0)/($30,000 + $0 + $0) x (1 - 0%) = 5.8%

So, if you did not include location specific values for state income tax, property tax and insurance the returns for all three locations would have been the same. Also, I have not considered other factors that can greatly affect your real return like climate (maintenance), construction, property age, local regulations, eviction cost and time, etc.

Market Changes

"The only constant in life is change." (Heraclitus) This statement also applies to investment locations. A property can generate a high return today and 10 years later can generate a loss due to changes in the local market. Below are some of the most common factors that alter asset value and return:

Population - If the population in the specific area (not just the metro area) is declining, then property prices and rents are likely to fall. Las Vegas metro population is projected to increase by 1% to 2% per year for the foreseeable future according to the linked study.

Urban Sprawl - This is a factor I almost never see discussed but it is a critical factor over the long run. In every major city I've seen there are areas which were once the best places to live and over time have become distressed areas. The major cause of such a change is urban sprawl. 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 sufficient income move out of an area and 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 which few locations ever recovered. Below is a diagram showing the impact of urban sprawl on return over time. The colors represent monthly rent. Green represents a high rent and red represents a low rent. The diagram is overly simplistic but I believe it conveys the real risk urban sprawl presents to investors.

Las Vegas is completely surrounded by federal land and almost all the available land is built out. The probable result of an increasing population and limited ability to expand (as shown on the map below) means that there is little chance of significant urban sprawl compared to most cities which have no such expansion limitations.

Business Risk - The best example of business risk to investors is eviction cost and time. I contrasted the eviction time between California and Nevada. Odds are that you would never face a nightmare eviction but it is sort of like cancer. If you hear of someone having cancer, it is a statistic. If it happens to you, it is a disaster.

Job Quantity and Quality - In many parts of the US, manufacturing and similar jobs have gone away and what remains are service sector jobs. Service sector jobs tend to pay less than manufacturing jobs so the families of these workers have less disposable income. Less disposable income means that they cannot afford to pay the level of rent they did in the past. According to the linked Federal Reserve study, Las Vegas per capita income has been slowly increasing (except during the 2008 to 2011 crash) and projections are that the increases will continue.

The Next Economic Crash - The crash of 2008 hit most of America hard, especially Las Vegas. If you would like to see what happened to the class A and B investment properties our clients owned in Las Vegas, please click the link titled, "Case Study - Las Vegas and the 2008 Market Crash" on my profile page. I would include the direct link here but the moderator would not allow it.

Las Vegas Real Estate Investments

I addressed your specific comments on Las Vegas investing below. If you would like to read more about Las Vegas as an investment location, please click the link titled, "Is Las Vegas for You?" on my profile page: Link.

Are properties overpriced? - In my opinion no, based on at least three factors:

• Replacement value - When you obtain insurance, one of the cost drivers is the cost to replace the structure if the property burns to the ground. Since the crash, the replacement value has been (and remains) higher than the property purchase price.

• Build cost - In all the cases I have seen the $/SqFt cost for new homes is significantly more than that for resales.

• Current price vs. the price before the crash - According to the linked article, home prices in Las Vegas are still 44.5% below their peak prices before the crash.

How much do typical investment properties cost in Las Vegas?

• Class A properties: generally from $160,000 to $240,000

• Class B properties: generally from $130,000 to $200,000

• Class C properties: generally from $50,000 to $150,000

What are typical returns on class A and B properties? - These are properties which we feel offer a balance of current return and probable appreciation. We are typically seeing between 4% and 8% using the formula shown above. And, since rents are rising, we expect this rate of return to continue due to the increasing population and the limit to expansion.

Are good properties hard to find in Las Vegas? - Yes. Good properties represent between 0.05% and 0.1% of available properties. We are only able to consistently find good properties because of the analytic software we developed, the evaluation/selection process and rehab process we have in place, our investment team and our own personal investment experience. So, I am not surprised that you did not find good investment properties on your own, especially in the $150,000 range.

What is a "Good" Return - This sounds like a simple question and should have a simple answer. It does not because it depends on many factors including your:

• Alternative investment options

• Need for liquidity

• Financial goals

• Purchasing power

• Expected hold time

• Risk tolerance

To talk about these elements at any depth would require a lengthy document and beyond the scope of this reply. I will provide an overly simplistic answer but it still might be helpful.

There are only a few common "secure" investments. One that comes to mind is a CD. Here is a link to a number of CDs. Many of the rates are around 1.2% to 1.3% for a 1 year CD. Since the official inflation rate is about 3%, at best you lose about 1.6% in purchasing power after the year plus you will pay taxes on the gain. However, CDs are secure so you are very unlikely to lose your principal. If you buy class A real estate in a good area, you will generate higher return, virtually forever since rents track inflation while your largest cost is fixed. And, while properties generate a positive cash flow, you may have a tax loss due to depreciation and other real estate friendly tax rules. But this only works if you buy properties in a location with a high probability of appreciation and your selection met all or most of the long term factors I listed earlier in this article.

Dan, this is a long answer to your post but I hope you will find the material useful.