How are investors making money in Las Vegas rentals?

[Jack B.]

I'm looking at houses in Las Vegas that unless you pay cash, don't cash flow at all, and in most cases are a loss. So how are people making money with rentals in Vegas on 20-25% down financed properties? Appreciation only?

I ask because I've visited the area twice recently and can't seem to find any real estate there that cash flows worth a damn, if at all.

[Eric Fernwood]

Hello @Jack B.

The short answer is yes, there are good investment properties in Las Vegas. I define a good investment property as one that meets all three of the following criteria:

• Sustained profitability - The property must generate a positive cash flow today and into the foreseeable future.
• Likely to appreciate over time.
• Located in an area where you can make money and business risks are low.

The above criteria is a combination of location, the individual property, legislation, ongoing demand and other factors. I will talk more about this a little later once I provide a more comprehensive answer to your question.

Are there good buys in the current Las Vegas market? Yes. There are not a lot but we find them all the time. What level of return can you expect? Between 3% and 5% on class A properties (financed, 20% down, including all recurring costs). However, there are many ways to calculate return and some formulas do not include all recurring costs while others include principal reduction and other such unrealized gains. The formulas we use for comparing properties are below. Note that we do not include a constant for vacancy rate or maintenance when we compare properties. These two factors are property specific. Also, we do not take into account personal income tax benefits which generally increase effective return.

ROI = (Income - DebtService - ManagementFee - Insurance - RETax - PeriodicFees) x (1 - StateIncomeTax) / ( DownPayment + ClosingCosts)

Cash Flow = (Income - DebtService - ManagementFee - Insurance - RETax - PeriodicFees) x (1 - StateIncomeTax)

Note: There is no personal state income tax in Nevada but we include this variable (StateIncomeTax) for when we compare properties in states that do have a personal income tax. For a return comparison between a similar property in Austin, Texas and a similar property in Las Vegas, see this post. This post demonstrates the impact of property taxes and insurance has on return.

So, why should you consider investing in Las Vegas? Two reasons: current and future return. First, current return.

Current return - ROI and cash flow only indicate how the property will likely perform today. Below are examples of short term cost factors.

• Price
• Property tax (~0.55% in Las Vegas)
• Insurance (~$450/Yr on a $200,000 single family home)
• Periodic fees
• Management cost
• Financing cost

Remember that ROI and cash flow are only snapshots in time and that the only constant in life is change. Like an elevator, they can either go up or down but rarely stay in one place.

Long term profitability is a function of demand. Below are some of the factors which affect demand.

• Population trends
• Urban sprawl
• Job quality and quantity
• Regulations
• Ongoing maintenance cost

Below are notes on how I believe Las Vegas will perform in the foreseeable future.

Population trend - Depending on which study you read, Las Vegas’ population is expected to continue to grow at a very desirable 2-3% per year.

Urban sprawl - While not largely discussed, this is a major factor to consider. In every major city I’ve seen, there are areas that were once “the place to live” and are now distressed areas. This is usually the result of urban sprawl. People want newer floor plans, better schools and more space. So, they move to newer areas. The people who remain generally have lower incomes thus driving down home prices and rental rates over time. Note that such declining markets can be very appealing because they can have high returns today as rents tend to lag sales price by (depending on which study you read) 3 to 10 years. Below is a diagram I created to illustrate the effect urban sprawl can have on investments over time as higher income families move to newer areas.

Las Vegas is completely surrounded by federal land; there is very little land left to develop. Las Vegas’ only growth path is redevelopment. Today’s class A properties will very likely remain class A properties in the future. See the map below.

Job quality and quantity - The value of a property is no better than the jobs around it. In many parts of the US, manufacturing and similar jobs are going away (or have already left) 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 today than they did in the past. Less disposable income means that they cannot afford to pay the level of rent they did in the past. A key indicator is inflation adjusted per capita income over the past few years. If inflation adjusted per capita income is flat or declining, you need to carefully consider the long term value of the investment before you buy.

Inflation adjusted income in Las Vegas has been slowly increasing (except during the 2008 to 2011 crash) and projections are that the increases will continue according to a Federal Reserve Bank study.

Regulations - State/county/city legislation can make an otherwise great investment a financial disaster. One of the easiest barometers is the time and cost to evict a non-paying tenant. It can take up to one year to evict a non-paying tenant in California. In some cities you can not evict during the winter. Other places have rent control and other regulations that curtail ownership rights. In Las Vegas, there is no rent control and evictions usually take less than 30 days and cost less than $500. If you owned 10 properties in California, will you have a nightmare eviction? The odds are low. However, nightmare evictions are like cancer. If it happens to someone else, it’s a statistic. If it happens to you, it is a disaster.

Ongoing maintenance cost - When I owned properties in Atlanta, Houston and other places, I was always replacing roofs, siding, wooden windows, dealing with termites and the landscaping. These costs were a continual drag on profitability. Below are some generalizations about ongoing maintenance costs:

• Older properties require more maintenance than newer properties.
• Composition roofs require more maintenance than tile roofs.
• Properties in climates with hard freezes require more maintenance than properties in milder climates.
• Properties in locations with a lot of moisture require more maintenance than properties in dryer climates.
• Wood siding requires more maintenance than aluminum or stucco siding.
• Properties with lush vegetation require more maintenance than properties with little or no vegetation.

Below is a typical Las Vegas single family class A home.

In summary, I believe Las Vegas is not only a good place to invest today, it has a high probability of continuing to be a good investment location into the foreseeable future.