Most of our clients live in other states or countries and one of the first questions I get from new investors is, "Why should I invest in Las Vegas?" My response is usually, "What are your goals?" It is important for me to understand their goals before answering the question because Las Vegas will not meet everyone's goals. In this post I will discuss where I think Las Vegas is strong and where I think it is not as strong. Note that I will focus on single family properties, the multifamily and commercial markets are quite different.
So we are on the same page, I believe every investment property/location must meet three criteria:
- Sustained profitability - The property must generate a positive 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 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 in fees) to evict them, not to mentioned the lost rent during the eviction period. In comparison, in Las Vegas it takes 28 days to evict a non-paying tenant and usually costs less than $500.
The key profitability factors can be subdivided into short term and long term (10+ years). Short term factors determine how the property is likely to perform today but tells you nothing about how it will perform in the future. Long term factors tell you how return is likely to change in the future but nothing about how the property will perform today.
Short term factors:
- Price range
- Real return
- Rehab cost
- State income tax (Only if the investment property is located in your tax home state and your state has a personal income tax.)
Long term factors:
- Population trends (Migration and urban sprawl)
- Job quality and quantity trends
- Regulations (Example: eviction laws)
- Ongoing maintenance costs
- Probable appreciation
Short Term Factors
One of the areas where I think Las Vegas does not appear as strong as some other locations is the initial purchase price. The following are typical price ranges in Las Vegas.
- Class A properties: generally from $180,000 to $230,000
- Class B properties: generally from $120,000 to $180,000
- Class C properties: generally from $50,000 to $120,000
However, ROI and cash flow are what matters most, not the initial purchase price. So you need to look at the real return (Compare apples to apples).
When you are comparing properties in different locations, you need to include all the recurring costs in your calculations. In most locations, the major recurring cost elements include the following (ignoring state income taxes for the moment):
- Property taxes
- Landlord insurance
- Management fees
- Periodic fees (association fees, assessments, etc.)
The formula we use for return is:
In order to demonstrate the impact of property tax and insurance has on return I put together the following (contrived) example. Note that I did not include state income taxes and rehab costs for the following reasons:
- If you buy properties in your tax home state, state income taxes on rental income will be at your marginal tax rate. Depending on the state, this could decrease your return by as much as 13%.
- Rehab costs vary wildly. In Las Vegas we are typically seeing between $3 and $5 per square foot. In a recent article titled "What It's Actually Like To Buy A $500 House In Detroit", the author estimated that rehab costs in Detroit average $75–$100 per square foot, and "that's just for bare-bones repairs, it doesn't include anything structural like a roof or foundation". So, for a 1,000 SqFt house you would spend $75,000-$100,000 in rehab.
If the exact same property, in three different cities, rented for the same amount with the same financing terms the only difference in return would be due to property tax and landlord insurance rate differences. The specifics of the example property are below.
- 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 Amount: $30,000
- Periodic fees: $0
- Management fee: 8% or $12,000/Yr. x 8% = $960/Yr.
- Rehab cost: $0
Calculating ROI for each of the three cities:
Austin: ROI = ($12,000 - $7,296 - $960 - $1,625 - 1.9% x $150,000 - $0) / ($30,000 + $0 + $0) = -2.4%
Indianapolis: ROI = ($12,000 - $7,296 - $960 - $802 - 1.07% x $150,000 - $0) / ($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) = 5.8%
As you can see, property tax and landlord insurance had a significant impact on return. This is an area where Las Vegas has a clear advantage: low property taxes, low insurance rates and no state income tax.
Long Term Factors
Long term factors can change a high return property into a money pit. Below are some of the more significant factors.
If people are moving out of an area, housing prices and rental rates are likely to fall due to decreasing demand. If people are moving into an area, then there is likely to be appreciation and rising rents due to increased demand. However, even if the general area population is stable, specific sub-areas could be losing population. One major cause of this is urban sprawl. People want newer floor plans and newer homes and, if they have the money, they will move to areas where they can buy such properties. As people with money move out of an area those left behind will, on average, have lower incomes. Property prices will then start to fall due to decreased demand. As property prices fall, property tax revenues will fall. City services are largely dependent on property tax and sales tax revenues so as these fall, cities have no choice but to cut services. This starts a downward trend from which few locations have recovered. There are exceptions, but not many.
Las Vegas is one of the few major cities not subject to urban sprawl because it is virtually an island; it is surrounded by federal land. The map below shows the Las Vegas metro area. The gray area is federal land.
Below is a map showing the closest alternative cities. As you can see, there is little development within commuting range outside of the Las Vegas metro area. Also, since most properties in Las Vegas are still selling below replacement cost, prices in the few surrounding cities are not significantly less than metro Las Vegas so commuting does not make economic sense.
As far as Las Vegas population trends, depending on which study you choose to believe, Las Vegas' population is projected to increase by 1% to 2% per year for the foreseeable future. When you combine a growing population with no room for expansion I feel that appreciation and rent increases are almost inevitable.
Job Quantity and Quality
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 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. A key indicator is inflation adjusted per capita income over the past few years. If you see an adjusted declining per capita income you need to carefully consider the long term value of the investment.
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.
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. I mentioned the time and cost to evict non-paying tenants in California previously but there are many other locations with such regulations. Another investor told me that it can take up to 18 months to evict a non paying tenant in certain areas of New York state. Also, in some cold climates you cannot evict non-paying tenants in the winter. I view the effect of such regulations like I view cancer. If it happens to someone else, it's a statistic. If it happens to you, it is a disaster.
Ongoing Maintenance Cost
Ongoing maintenance costs can have a significant impact 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 home.
As you can see, there is not a lot to maintain.
If you are looking for low cost, high return (+10%) properties and do not care about appreciation, Las Vegas is probably not your best choice. If you are looking for a sustained moderate return (4% to 8%) with probable appreciation, low maintenance costs and low risk and are comfortable with the purchase prices, you should consider Las Vegas.