In The Lair of The Pessimists

If you want to find the most pessimistic Las Vegas pessimists, you have to leave town and travel to Chicago, where you’ll find the exchange that trades futures contracts in Las Vegas real estate.

This is a place where you can gamble on where the Las Vegas market is going, and that’s just what I did earlier this week, aided by Frothing Brooks.

I purchased 3 contracts of Las Vegas Housing November 2012 contracts, and my strike price was 142. That number corresponds to the Case Schilller index number for Las Vegas.


Here’s how it works. Case Schiller for Las Vegas right now is at 177. These numbers are index numbers. It means that Las Vegas real estate, in February (Case Shiller is always a few months behind), was valued at about 1.77 times where it was in January 2000.

My bet will payoff if I can sell the contracts at a price higher than 142. I have to do this prior to the expiration of the contract in November 2012.

Now, a level of 142 is 20% lower than the current level. Let’s say that there was a foreclosure house that sold in February for $200,000. A 20% reduction from that level would be $160,000. So, in order for my bet to payoff, that house has to be worth more than $160,000 in November, 2012. If it’s worth, say, $175,000, the Case Shiller index for November 2012 will be down 12.5% from the 177 level it is now, or 156. In that case, I would make $10,500 on the 3 contracts I purchased at 142.

Think about what that means.

Houses that sold in February were already trading WAY down from the market peaks. They are already 20% or more off of 2005/2006 levels. The only way I lose is if the market dumps another 20%, and then stays there for THE NEXT FOUR YEARS.

In that case, I will break even.

In futures trading, you’re always betting against someone else. Someone sold me those 3 futures contracts. In order for them to win, they need to have the market drop 20% from February’s prices, and then dump another 10% or so. So they’re betting that a foreclosure that people are scooping up today for $200,000 will be selling for $140,000. At the end of 2012. After we’ve added another 250,000 new residents to Las Vegas.

Hell, at $150,000, you can generate 6% returns with just $1000 per month in rent.

But wait, there’s more.

Consider inflation. Case Shiller is not indexed for inflation. What does that mean? Well, normally, inflation is around 2-3% a year. So between now and November 2012, we can expect about 10% inflation. The more inflation there is, the better my bet is and the worse off my counterparty is. Suppose that everything inflates 10%. That means that a house that cost $200,000 would now cost $220,000.

So, in order for my bet to fail, prices have to fall to $140,000 even with inflation of 10%. That means in real dollar terms, prices would have to fall an additional $20,000 to $120,000.

If this was a contract that expired in November 2008, that would be one thing. Although I have predicted that April 2008 will turn out to be the bottom of the market due to the lusty foreclosure bidding wars that are taking over, it’s a reasonable bet for someone to assume that prices will fall through the end of this year.

But a bet that they’ll fall for the next four years displays a terrible ignorance of key economic truths about Las Vegas. The hotel investment. The new jobs (12,000 new direct jobs at City Center alone, with hiring starting in January, the desirability of Las Vegas as a tax haven and a retirement playground. The lack of buildable land in the Las Vegas valley, the lack of in-construction backlog of housing, the lack of new construction, the increases in commodity costs and code complexity that make it more and more expensive to build new residential. I’ll talk more about these factors some other time.

Why is someone willing to bet their own money that Las Vegas will fail that badly over the next four years?

It’s called “overshoot”. What it means is that booms go too far, and busts go to far. People with little knowledge of Las Vegas fundamentals are so terrorized by the short-term factors like heavy foreclosures that they think this is a good bet.

I think I’ve made a really good bet here.


One Response to In The Lair of The Pessimists

  1. […] read the sage of Frothing Developer’s commodity bets on Las Vegas, start here, then go here and […]

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