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Blackstone’s Bellagio bet cashes in on the institutionalization of casinos

Amid a global gambling boom, casino operators are becoming more like hotels, creating an opening for institutional capital.

bellagion casino resort las vegas
Gaming: Institutional capital's latest bet

Blackstone is betting on the future of gaming real estate with its $4.25 billion purchase-and-leaseback of MGM’s Bellagio in Las Vegas. The New York-based mega manager is cashing in on a gambling boom and growing willingness by casino operators to divorce themselves from their real estate.

Indeed, MGM is one of three prominent operators monetizing its property holdings, spinning out 13 of its US assets into a real estate investment trust, MGM Growth Properties. Alongside the Bellagio, the company also sold the casino resort Circus Circus to Phil Ruffin, owner of Treasure Island, for $825 million. These divestments are part of a US-focused ‘asset light’ strategy by casino operators, despite coming amid a gaming expansion on both sides of the Pacific.

In the US, the Supreme Court struck down a federal ban on sports betting last year. That boon for gambling comes as the number of states permitting commercial casinos has doubled since 2000. During that same timeframe, Macau, the Chinese special administrative region – and the largest gambling market on the planet – has been transformed from a government-sanctioned monopoly into an institutionalized resort destination. Elsewhere in Asia, Singapore opened its first casinos in 2010, Japan is angling to follow suit in the coming years and Vietnam is experimenting with legalized games of chance amid its own resort development spurt.

However, the possession of the facilities that accommodate gaming is in a state of flux. For decades, large casino resort owners clung to their underlying real estate. But now, as the sector continues to mature and regulation becomes more accommodating, more operators are open to alternative property ownership structures. During the company’s third quarter earnings call, MGM chairman and chief executive James Murren called the Bellagio sale “a likely blueprint for the future” and noted a similar approach could be used to liquidate its interest in another marquee property, the MGM Grand Las Vegas.

“We’re really excited about the phase that we’re in now,” Murren said on the October 30 call. “After a lot of work, we can see what our end-state will be and anticipate a future MGM Resorts that does not need to own meaningful real estate assets.”

A hedged bet

Managers have tended to avoid hotels because of their volatility; to them, gaming-oriented facilities, such as the Bellagio, have been considered even more daunting as their main revenue comes from the casino floor, PERE hears, making them more like operating companies than typical real estate assets.

Corporate private equity regularly invests in gaming operators, with casinos purchased with opportunistic returns in mind. Blackstone, for example, bought The Cosmopolitan in Las Vegas at a distressed discount price of $1.73 billion in 2014. It stabilized the property by renovating more than 3,000 rooms, adding 21 new penthouses and executing various other capital improvements. It still owns and operates the casino resort, which neighbors the Bellagio.

Colony Capital is another prominent manager to dabble in the gaming market, albeit unsuccessfully. The Los Angeles-based firm purchased five resorts and one riverboat casino between 2000 and 2005, but struggled to keep them running through the global financial crisis. It defaulted on loans for all five resorts – two apiece in Atlantic City and Tunica, Mississippi, as well as the Las Vegas Hotel & Casino – between 2009 and 2014. It was able to sell the boat, Resorts East Chicago, for $675 million in 2007.

The Bellagio deal, however, is the first example of a manager acquiring a Las Vegas resort as a long-hold, core asset. In Blackstone’s third quarter earnings call, chairman and CEO Stephen Schwarzman said the transaction highlighted the firm’s convictions about live entertainment, “because even though many things are moving online, people still need physical activities, things they want to do.” Blackstone also insulated the deal from the sector’s underlying volatility, market sources familiar with hospitality investment tell PERE.

For one, the Bellagio transaction is structured as a sale-leaseback, with the purchasing joint venture a 95:5 ownership split between Blackstone’s Real Estate Income Trust and seller MGM. The resort specialist will remain a tenant in the property on a triple-net basis, meaning it will be responsible for all operations and capital expenses for what is effectively a 50-year term – 30 years initially with two 10-year extensions, according to a Blackstone filing with the Securities and Exchange Commission.

Rent will increase annually in line with inflation, with progressively higher caps over time. The lease is expected to carry a full corporate guarantee from MGM, which is publicly traded with a $15 billion market capitalization. Analysis from UBS Securities, an affiliate of the Swiss bank, also points to MGM using a “leveraged partnership” strategy on the deal, meaning it would guarantee the loan on the acquisition. Doing so allows the company to realize proceeds of the sale without being taxed on the capital gain immediately. This also helps shield MGM from being taxed on a future sale, such as the MGM Grand.

Rent starts at $245 million, half of Bellagio’s EBITDA in 2018. This gives Blackstone ample cover in case of a downturn, Kevin Colket, founder and chief executive of Hong Kong-based Global Hospitality Investment Group, tells PERE. Often, buyers in sale-leaseback arrangements look to capture a greater share of a tenant’s revenue through rent. But Blackstone’s conservative underwriting gives it a buffer in case of a downturn while also ensuring a strong annual yield. Also, if MGM defaults, Blackstone would take possession of the property at a relatively low cost of capital, he says.

“This is really pioneering in the sense that they’ve been able to craft a really good risk-adjusted return strategy,” Colket, formerly managing director of Asia for Starwood Capital, says. “They get their returns and take incredibly low risk because there’s so much underlying value to the real estate, they have two times coverage and a corporate guarantee.”

REIT it and reap

Penn National Gaming was the first casino operator to spin its property into a REIT. It launched Gaming and Leisure Properties in 2013 to return cash to investors and reduce the tax implication of owning its own real estate. The Pennsylvania-based company rolled 21 of its 29 assets at the time into GLPI, placing most of these under a master lease.

Research analysts at Sydney-based bank Macquarie Capital refer to GLPI as the only “pure-play REIT” in the gaming space. With a diverse mix of tenants, it focuses on regional casinos rather resort destinations and has closed $6.8 billion of acquisitions since going public. It now has 46 properties. MGM formed MGM Growth Properties in 2015, but its only assets are its own US resorts and the operating company still controls a two-thirds stake in the REIT. The third trust is Vici Properties, which spun out of Caesars Entertainment Corporation in 2017 as part of a bankruptcy reorganization.

Murren says the move to go “asset light” allows MGM to focus on its “core competencies as a developer, manager and operator” of gaming facilities. The REIT structures also enable it to access capital from the public markets. The three gaming REITs and Blackstone’s BREIT have transacted on $22 billion of acquisitions since 2013, including $13 billion since last year alone, according to Macquarie research. Throughout the US, 15 publicly-traded gaming companies own 465 commercial casinos. That leaves room for growth in this space, experts say.

Subsequently, the US is slated to see more regional casinos developed soon. Pennsylvania and Massachusetts can still issue one gaming license apiece, per a report on gaming from Green Street Advisors’ Advisory & Consulting arm. Macquarie notes that states often legalize commercial gaming to make up for lost tax revenue after economic downturns, pointing to Kansas, Ohio and Maryland in the wake of the global financial crisis. Other states, including Virginia, Texas and Georgia, also are considering an affirmative move to increase gaming.

Longer-standing are Native American tribes, which can operate casinos in 29 states. Such assets can be difficult for institutional capital to acquire because tribal lands are subject to their own legal systems. But some firms have forged partnerships with tribes.

New York-based manager Sculptor Capital Management, for instance, has been active in the gaming real estate space for 12 years, working both with regional commercial and tribal casinos. Today, such property makes up 18 percent of its real estate under management, its biggest single asset class exposure. Mark Schwartz, managing director and head of gaming investment at the firm, says funding the development and expansion of tribe-owned facilities has led to steady cashflow returns with limited competition. “What has attracted us to Native American gaming is its outsized growth versus commercial gaming, and more limited institutional capital in the segment,” he says.

High rolling in Macau

Infrastructure: A new cross-ocean bridge connects Macau and Hong Kong.

Half a world away, Macau brought in some $38 billion of gross gaming revenue last year, more than three times the entire state of Nevada. One operator, Las Vegas Sands, reported $6.8 billion in gaming revenue from its five Macau resorts in 2018, more than the entire Las Vegas Strip.

As the only legal gaming hub on Chinese soil, the special administrative region (SAR) has become something of a “pressure valve” for the country’s thirst for gambling, says Tom Ashworth, partner at Macau-based Sniper Capital. “It’s like having Las Vegas located just off the cost of California and within one hour you’ve got New York, San Francisco and Orlando,” he says, referring to the many dense cities surrounding the nearby Pearl River Delta, an area that has a larger population than the UK.

After years of local control, in 2002, the Chinese government opened Macau up to outside gaming operators, including US-based Las Vegas Sands, MGM and Wynn Resorts, Hong Kong-based Galaxy Entertainment Group and Japan-based Melco Holdings, alongside the Sociedade de Turismo e Diversões de Macau, which previously held a government-sanctioned monopoly on gaming for decades. Since then, gaming revenues have skyrocketed from $2.9 billion to a peak of $45 billion in 2013.

Despite strong gaming revenues, real estate activity in Macau has faltered in 2019. Real Capital Analytics tracked just $134 million of investment-grade transactions – those valued at $10 million or more – through the first three quarters of the year, compared with year-end totals of $886 million and $955 million in 2017 and 2018, respectively. All the purchases were made by operating companies, local developers or high-net-worth individuals, with large private real estate funds remaining on the sidelines.

Tight regulations restrict which companies can build, own and operate casinos in the city. But some real estate investors and developers have found opportunities in related property types that serve the city’s booming tourism industry. The number of visitors in 2019 is projected to hit 40 million, nearly double what it was a decade earlier. This surge of visitors is likely to continue thanks to the recent completion of the Hong Kong-Zhuhai-Macau Bridge, a 34-mile cross-ocean bridge-tunnel system that connects Macau to Hong Kong and its international airport. Sniper manages a pair of closed-end funds to address the shortage of food and beverage retail and non-gaming entertainment, one focused on new development, the other on redeveloping legacy properties.

Macau is also underserved in terms of number of hotel rooms with fewer than 40,000, according to data gathered by Las Vegas Sands, compared with more than 125,000 in Las Vegas. The city has ample room for new development along the Cotai Strip, a piece of reclaimed land just south of the Macau Peninsula, but further expansion is on hold until Ho Iat-seng, the newly appointed chief executive of the SAR, is sworn into office on December 20.

One of his first orders of business will be addressing the casino licenses in the city, and while Ho is expected to grant a two-year extension to the current operators, there will be little new investment in gaming facilities until a longer-term solution is in place, Ashworth says.

While it embodies the pinnacle of gaming success on one hand, Macau also showcases how fickle it can be. Operators are subject to the whims of the Chinese government, which could revoke their licenses or compel them to finance more development. Conversely, it could issue more licenses and flood the market with competition.

This could be considered an extreme case, but it also serves to demonstrate how gaming companies in all mature markets are vulnerable to some level of regulatory variability, regardless of which kinds of investing profiles or vehicle structures are adopted.

“It’s certainly a risk that we have to consider in these types of transactions,” Schwartz says.