Today’s Wall Street Journal reports that MGM Mirage is cutting the price of the condominiums in its spectacular City Center project in Las Vegas, Nevada. How big a cut? Thirty percent! We’re not sure what their margin is, but that’s probably all of it and then some. Ouch.
Worse, it’s probably still not enough. But only time will tell. The cuts are a little surprising to us, but clearly they’re the result of a major reality check for MGM Mirage. And this post isn’t really about Las Vegas, MGM or City Center. It’s about the LESSONS available in this situation for all of us.
Lesson #1 – The market sets the price. Whatever MGM needs to cover its cost is interesting, but only to MGM. The market decides what its willing to pay. In this case, MGM is hoping it’s just 30% off. Before it’s all done the market may want more.
Lesson #2 – The market is fickle. Three years ago people were willing to pay more. That’s why MGM sold so many. People had equity, unemployment was half what it is today, financing was readily available for almost anything related to real estate – even condo-hotels. But a funny thing happened on the way to the closing table. Okay, not so funny. But the stream of foreign money through Wall Street into mortgage backed securities got shut off almost over night, taking with it equity and working capital. A market heavily driven by momentum did an abrupt 180. Whether you’re rehabbing a fixer upper or building a skyscraper, if your success requires you to find a ready,willing and able buyer (or in MGM’s case, thousands of them), you better get to market fast – because things can change.
Lesson #3 – Have a Plan B. Donald Trump’s Plan A was to sell the condos in his Las Vegas project, just like MGM and every other developer participating in the Las Vegas rush for real estate gold. When Plan A bit the dust, he converted the project into a hotel. Still a tough gig, but the goal is to get some cash flow to hold the property until things improve. Rich Dad Advisor and Robert & Kim Kiyosaki’s investment partner Ken McElroy says they only do deals they can afford to stay in for 10 years. Plan A may be to build or fix up for quick sale, but Plan B is to structure the deal so it still makes sense if they have to hold. Plan A is a win and so is Plan B.
Lesson #4 – Understand the other party’s needs, wants and desires. When you’re in a deal that’s going sideways, whether for reasons under your control or those not (certainly MGM could not predict, much less control the mortgage meltdown), it’s easy to fixate on your own pain. If buyers aren’t willing to close on City Center, should it be assumed they are unwilling because of the price? Could they be unable because of lack of financing? Could they be afraid of reduced rents on their units due to the soft economy? Until you know what the issue are for the other party (again, in MGM’s case, thousands of them), you might give up or give away profit unnecessarily.
Lesson #5 – Use Creativity to Protect Profits (or minimize losses). Certainly we don’t know all the considerations for MGM, and presumably these are extremely smart people, but we know many investors who are in contract for units in City Center and we haven’t heard any discussion of owner financing. We know that condo-hotel pricing has all but disappeared. For many buyers getting a conventional third party loan is an impossibility. But what if City Center carried back the financing? It doesn’t get cash, but it gets an asset (a mortgage). For those buyers who need income to service the mortgage, couldn’t MGM as the hotel operator, steer more guests into the unit? After all, they still get their operator’s share of revenue, plus they get the mortgage payment. The owner may need to kick in a little cash flow to feed the mortgage, but better than losing one’s deposit. After all, it’s still one of the premier properties in the country. Where do you think values will be in 20 years?
You may not be a Big Time Operator like MGM. But real estate is real estate and when you watch what’s happening for the BTO’s, many of the lessons will apply to you.