Consultant John Restrepo, principal of Las Vegas–based RCG Economics, remembers what things were like in Las Vegas in the mid-2000s. Developers, fueled by a dangerous mix of greed, arrogance, and delusion, were determined to build at all costs. They were convinced that they’d always have demand for their units. And then many were left with a glut of properties and assets, but no buyers. “There was a view in Vegas that we had conquered the cyclicality of real estate, that there was nowhere to go but up,” Restrepo says. “A number of promoters wanted to Manhattanize Las Vegas. They believed there was huge pent-up demand for high-rises [in Sin City].”
They were wrong. The problem? Las Vegas wasn’t, and never will be, Manhattan. Yet overindulgent developers with visions of building grand residential towers convinced themselves that there was a market to be had. At one point, Restrepo says he counted about 20 projects with 20,000 units total in Las Vegas in the works. In some cases, seasoned developers were making these miscalculations. In others, it was just a couple of newbie yahoos with visions of glory.
“It was ridiculous,” Restrepo says. “Every day that you turned around, there were two guys from the East Coast with a website and a dream of the most distinct high-rise project ever built. If you questioned any of it, they’d look at you like you were raining on their parade.”
Vegas’ risk-taking developers were not alone. In the mid-2000s run-up, builders in major cities such as Miami and Phoenix flooded the market with a supply. When the party ended, the glut began. In the years since, developers have slammed the brakes on construction projects. Development went from 315,000 multifamily starts in 2003 to 97,000 in 2009, according to Census stats.
These days, given the demand for apartments, the country is losing about 115,000 units per year. Meanwhile, places like Texas and the Washington, D.C., metro are seeing substantial starts. All told, 81,300 units are expected to be delivered in 2011, with that number growing to 189,700 by 2013, according to Dallas-based consultant Witten Advisors. “Some markets are perennially overbuilt,” says Grant Montgomery, a vice president at Alexandria, Va.–based research firm Delta Associates.
Even though many of these overbuilt units in Miami and Las Vegas were condos, the excess inventory sapped rental demand in these markets. And this cycle wasn’t even the worst for overbuilding, according to some experts. “In the ’80s and ’90s, it was overbuilding that ended the good times,” says consultant Ron Witten, president of Witten Advisors. “In the 2000s, it was economic conditions that ended the good times. We didn’t see spikes in production for rentals.”
Witten, for one, doesn’t expect to see overbuilding happening again. In the ’70s and ’80s, a tax code provision emerged that allowed passive investors to claim tax credits for apartment investment, spurring new development. Things today are different. “The incentives are for building where there’s demand, and you can make a good return,” Witten says. “When that stops being in place, the money stops flowing. It’s not a perfect process, but the incentives are market-driven, as opposed to some artificial influence like tax shelters.”
Most developers, who by nature of their business are optimistic, don’t seem concerned. That’s certainly easy to understand: Only a year or so ago, no one was getting financing. Meanwhile, today’s starts are only a portion of where they were in the heyday. “There are financing constraints that will create a governor on new supply,” says Charlie Brindell, CEO of Mill Creek Residential, a private builder based in Dallas that is projecting 5,500 starts in 2012.
Others agree. “It will take many years to overbuild the aggregate market,” says Ryan Dearborn, CEO of Atlanta-based Wood Partners, a private developer with a 2012 pipeline of 4,000 units. Eventually, as lenders start drinking the Kool-Aid and lending standards loosen, development will grow. On that point, there is no dispute. It has happened in every past real estate cycle, and Montgomery expects it to happen again. “Real estate is one of our most consistent cycles,” Montgomery says. “We have overbuilt in the past. We will overbuild this cycle. It will happen. The question is, when?” —L.s.