Las Vegas Housing Market: Solutions and Expectations
Editor’s note: This is the fourth of a five-part article by urban infill real estate developer Jim Noteware.
Part IV
What Are the Solutions? What Can We Expect?
Before discussing the solutions, we must go to the third factor in recognition (the first, we have a problem; the second, that markets suspend transactions at their peak). The third factor is: Let’s get real. Many professionals involved in workouts of troubled properties liken the workout process to the psychology of those informed of impending death: first is disbelief; then denial; then anger; and ultimately, recognition and resolution. It is only upon recognition that the recovery can begin. So, most fundamentally, to achieve recovery, we must recognize our situation and resign ourselves to the realities which will be required of recovery.
Absorption of Excess Inventory—As noted, we in Las Vegas are blessed by the strength of local demand—job and population growth. So now, let’s do some arithmetic—the numbers I believe will quantify the pace of our recovery, and the numbers I wish the media would analyze and report. Las Vegas adds about 80,000 people per year, but it loses some, too. These numbers are hard to discern, but let’s say, 10,000 people, for a net of 70,000. This seems to be what consultants and governments alike think is about right for the next few years. Each household has about two occupants on average—actually a little more than two, but I like to keep the numbers simple—so we will need about 30,000 to 35,000 housing units a year (leave aside for a moment the details about what type of product and the pricing to appeal to the greatest segments of demand). This is the demand.
The supply situation is a little trickier to judge: As noted, the unsold inventory of existing homes appeared to peak at about 25,000 units late last year. According to Jeremy Aguero, principal of Applied Analytics, the number at the beginning of 2007 is 21,000, which he terms “an eight-month supply.†So, the excess inventory is already being absorbed at, say, about 1,0000 units per month. With eight more months at this rate, the inventory will stand at about 13,000 units—perhaps about right. Note that the historical level of 10,000 units was too few to support the Clark County population and the growth of the Clark County population. That is why prices grew so fast when the inventory was this low. (This is analogous to the unemployment rate—if a steady economy needs an unemployment rate of five percent to accommodate transition, then an economy with an only three percent unemployment rate will feel wage pressure and some dislocations, such as has occurred in Clark County in some years past.) So, for steady prices, we need an ample supply of inventory, probably in the range of 13,000 to 15,000 units.
So, if Jeremy Aguero’s eight-month estimate is correct, then we should reach balance by this coming summer. Markets behave in advance of statistics, however, and there is likely to be tension in pricing and inventory well in advance of the summer. This leads me to the conclusion that—based on macro factors alone—the local residential real estate market should show strong signs of recovery in the mid-to-late spring. In fact, some observers note that there are recovery signs already beginning to appear: reduced buyer incentives, stronger buyer traffic. Those may be psychological as well as quantitative signals, but they are extremely important. They indicate the direction of the market, and as most market observers note: markets move first, then participants.
Reduced Prices—This macro behavior and timeline will only occur if participants behave according to other theory, and according to their own best interests as well. First and foremost, this means pricing. The behavior of market cycles at the top—the suspension of transactions, as noted above—only moves to the next stage when sellers realize the reality of their situation and cut prices. This step is absolutely necessary for recovery. Buyers will not return to the market until they believe that prices will not fall further and are likely to increase. Said another way, before prices can rise, they must hit bottom. It is in everyone’s interest, including the sellers’, that prices hit bottom as quickly and as clearly as possible.
Sellers must realize that they bear a price by holding a property in inventory, hoping to sell: there are actual costs of carry (utilities, maintenance, property taxes, etc.), but more importantly, the cost of the capital tied up in the property. Thus, a seller is wise to offer these costs as a discount up front to a buyer to encourage an early sale. The more dramatic the discount, the quicker the sale and, across the market, the quicker the recovery. For instance, when the RTC decided to find a market clearing price for real estate in many distressed markets in the early 1990s it sold at absolute auction: while the initial prices were by all accounts very low, the markets quickly responded, and within a short time, historical price levels had been attained. No one is suggesting that price reductions in Las Vegas currently need to be nearly as dramatic as the RTC was in Texas nearly 20 years ago.
From the Las Vegas market perspective, it does NO good to deny that market softness exists, and to deny that values have fallen. Prices must match these new values for transactions and market clearing to occur. Sellers find that their position improves when velocity and absorption recovers.
In Las Vegas, my observation is that the residential market conditions are ready for this price adjustment, and that it will be relatively shallow -- say, 5% to 10% across the board, or as Richard Lee says, “Big Deal†in historical terms. Once this happens, and the markets are perceived to “hit bottomâ€, absorption will resume -- slow at first, but then accelerate. The demand side will begin to express itself again, reflecting new economic growth. One caution, however, neither the rate of absorption nor the rate of future price growth will likely match the performance of the 2003-2006 period because the growth will occur without the influence of investors. Most investors have learned their lessons and will stay away for some time to come. The stock market’s appreciation will likely become more attractive to more investors.
More focused strategies / More focused merchandising—This pricing adjustment will be followed by more focused behavior by all market participants. Projects will be designed for specific market segments and price points. Profit margins will likely narrow since the demand, while strong, will not achieve its former levels. And land sellers will need to be patient as macro conditions adjust -- land sellers will realize their position as one commodity in the entire process as distinct to the position many held as the most important constraint. There will be much more attention paid to merchandising property -- and the residential brokerage business will mature rapidly in a Darwinistic fashion: those who truly add value for their clients with successful performance will prosper; those accustomed only to “taking orders†will find other lines of work.
Then, once new uptrends are clearly established, there will be consideration of new supply additions. New capital will likely re-enter the market only slowly, and will insist on very conservative underwriting, and high returns, in part to reflect their perception of risk. There is an irony here -- profit margins for homebuilders are lowest, even negative, at the top of the cycle (we have just seen that!); and they are highest at the bottom of the cycle. The reason for the higher margins at the bottom is that their costs shrink -- land sellers are more modest after waiting through the trough; contractors and their suppliers are hungrier after their sluggishness as well. And so forth all along the economic food chain.
Which brings me to another important observation -- in using the term participants, I mean far more than just buyers and sellers and their immediate advisors or brokers. I also include contractors, lenders, and other suppliers to the industry.
Jim Noteware, principal of Houston-based Noteware Development, specializes in infill projects in rapidly growing urban areas. In addition to Brickwater Condominiums in Las Vegas, the company is developing Sevilla in the Moon Valley area of Phoenix and The Jamestown adjacent to Candlestick Park in San Francisco.
Comments
Dude, have you not heard that the spring season is a complete and utter bust so far? Inventory did not peak in late 2006, it is higher today at over 25,000 and growing like crazy. 5-10% will be the dclines in prices by year end. Expect at least another 10% next year.
You just don't get it do you? People have stopped buying because it makes no economic sense to buy. Houses are too expensive relative to rents and incomes.
I went to look at a rental in Tudor Park, in Summerlin near Boca Park. The home I looked at was being rented for $1800 a month. Homes were also selling between $470-$515K.
With $0 down a $500K mortgage at 6.25% would be $3100. Add in tax, HOA, insuarnce and SID and it's up to $3700 at least. Take $500 off for tax deductions and it's a $3200 a month cost to own vs. $1800 to rent.
Only a complete moron would buy instead of rent. That house will have to fall at least $100K before it's even worthwhile starting to think about buying it.
Posted by: Are you kidding me | April 10, 2007 6:58 AM