It is arguably the most famous stretch of road in the world. The four-mile long Las Vegas Boulevard, popularly referred to as ‘The Strip,’ is a dazzling spectacle of neon lights illuminating a cluster of lavish casinos and upscale hotels. Flamboyance is everywhere, be it in The Bellagio’s iconic fountains, The Venetian’s faux canals or The Mirage’s fiery volcano. Its hotels have attracted millions of visitors from around the world.

Lately, these casinos have drawn in private real estate firms, too. What was once a marketplace with sporadic, one-off transactions has become notably more active in recent years. That has resulted in the meaningful institutionalization of the area, and seen casino operators cashing out of their real estate holdings via spin-offs and other alternate ownership structures.

Asset managers and gaming REITs have taken over, using creative deal structures familiar to many investors across the risk-return spectrum. The way these transactions are underwritten, coupled with the resiliency of the Vegas casino market and its dominant players, has also helped the sector’s performance hold up reasonably well, even during an ongoing and unprecedented global pandemic.

Hospitality sales in Las Vegas have reached new heights over the past three years, compared with previous years when sales averaged approximately $1 billion each year, according to research published by property services firm Colliers. An estimated $5.13 billion worth of hospitality transactions was completed in 2020, despite lockdowns and business closures. This year could be even more active. As of the end of Q1 2021, hospitality sales volumes reached $4 billion.

“Behind all of the volume in the gaming space and traditional hotel space on the transactions side is an unprecedented amount of liquidity in the market,” says Dan Peek, president of the hotel group at real estate advisory firm Hodges Ward Elliott.

Decoding the Venetian sale

Las Vegas, with the sheer size and scale of potential casino purchases, makes for an attractive hunting ground for this pent-up liquidity. Five of the top 10 casino asset sales over the past three years involved a real estate manager. Others were done by wealthy individuals, private equity firms and gaming companies, according to data shared with PERE by John Stater, research manager at Colliers.

The path for this trend first began with the ‘REIT-ification’ of Vegas real estate. The three dominant publicly traded REITs in the market currently were all born out of sale-leaseback or opco-propco transactions – a deal structure in which the property is separated from its holding or operating company, giving firms the option to take control of just the real estate, or just the operating company – with iconic casino operators. VICI Properties was formed after Caesars Entertainment’s bankruptcy in 2017; MGM Growth Properties (MGP) following a 2016 initial public offering process by MGM Resorts; and Gaming & Leisure Properties following the 2013 spin-out from Penn National Gaming.

“Investors in gaming operators like MGM want to see the company grow its core business, invest in digital gaming and be at the forefront of any changes in the industry. While the investors in gaming REITs such as MGP emphasize stable cashflows and dividends with internal growth stemming from contractual rent bumps, operators and REIT landlords are tailored to serving a different investor and different investment mandate,” says David Balaguer, senior associate at Green Street, a commercial real estate analytics firm.

Gradually, private institutional capital entered the fray, too, initially taking full ownership of casinos, including both operator and real estate. A prominent example is New York-based manager Blackstone’s acquisition of The Cosmopolitan in 2014 for $1.7 billion. Over the past five years, however, gaming REITs and private managers have increasingly formed partnerships to acquire assets through the opco-propco route.

“When you bring to bear efficient capital for the risk, it allows for valuations to rise and that has happened in Vegas for assets overall. One of the ancillary benefits of this opco-propco development in Vegas has been that an asset like The Cosmopolitan is worth more because multiples for assets have been re-rated,” says Tyler Henritze, head of Americas acquisitions for Blackstone.

“You are effectively taking an income stream from a casino and bifurcating it. One part is in the form of a lease owned by the propco. The valuation that investors will be willing to pay to purchase this lease income stream is higher than the other part, which is the operating income, because it has a senior position in the capital stack and is less risky,” explains Greg Ressa, head of global law firm Simpson Thacher’s real estate practice.

Vegas map

The latest casino bet offers a compelling perspective on one such approach. In March, New York-based private equity firm Apollo Global Management, through its undisclosed funds, agreed to acquire the operating company of The Venetian and other associated facilities for $2.25 billion from its long-time owner Las Vegas Sands. As part of the transaction, VICI Properties, a US experiential REIT, is acquiring The Venetian’s land and real estate assets for $4 billion. The $6.25 billion transaction – the first sizable deal in Vegas since the pandemic began – was executed on a 6.25 percent cap rate.

For Edward Pitoniak, VICI’s chief executive officer, the partnership with Apollo is a “productive coming together of different value models.”

“As a REIT, our value model is built upon predictable steady income. As long as we can produce that income, at a cost in line with our weighted average cost of capital, we are creating value for our shareholders. For any operator like Apollo, the value model is built around the opportunity to create incremental value by creating incremental profit,” he says.
The transaction is also notable for several reasons. Chiefly, despite pandemic-triggered distress, the pricing on The Venetian was in line with pre-covid cap values.

Pitoniak agrees that while the pandemic did not directly factor into the pricing, it was accounted for through certain downside protection measures. For example, Las Vegas Sands has agreed to guarantee Apollo’s rent obligations under the lease through to 2023, which Green Street described in a research note as an important backstop given Apollo’s limited operating experience.

“Covid-19 curtailed revenue and profitability for the big Vegas assets. We have accounted for that in the effective lease guarantee that LVS is giving Apollo through the end of 2023,” he says. “The vendor takeback loan that LVS is making to Apollo also provides value protection during the covid recovery period.”

Core capital’s casino chase

At the other end of the risk-return spectrum, within the opco-propco model, are the type of deals Blackstone has been pursuing in Vegas.

In February 2020, Blackstone bought a nearly 50 percent stake in the real estate of MGM Grand and Mandalay Bay for $4.6 billion. The remaining interest is held by MGP. This was preceded by the New York manager’s acquisition of a 95 percent interest in the real estate assets of The Bellagio from MGM Resorts for $4.25 billion in November 2019. The remaining 5 percent continues to be owned by MGM Resorts.

Both transactions are structured as sale-leaseback. Both investments were also made via its non-traded REIT, the Blackstone Real Estate Income Trust. In both transactions, the resort specialist MGM Resorts effectively leased back its real estate as a tenant on a triple-net basis. This effectively makes it responsible for all the operations, capital expenses and rental payments on a long-term basis. In The Bellagio’s case, for example, the lease term is 50 years – 30 years initially with two 10-year extensions, according to a Blackstone filing with the SEC.

“It works for us and our cost of capital to buy these senior positions in the real estate subject to very long-term leases. And it works for the operators because they can redeploy the capital into riskier, but what they think are higher, returning opportunities,” says Henritze.

Without the complexity involved in owning the casino operations, these transactions become suitable investments for income-focused, core capital. Long leases and stable cashflow, guaranteed by a corporate tenant, have bond-like attributes. In addition to the fixed rent obligation, there are other protections too. In the case of MGM Grand and Mandalay Bay, for example, Blackstone’s assurances from MGM included a mandate to invest 3.5 percent of revenues on a rolling five-year basis into capital expenditures at the two properties, as PERE has reported.

Such an investment approach has helped draw more institutional investors to casinos. “A lot of investors would just draw the line and say, ‘No, we are not comfortable with owning a gaming operation.’ But they are comfortable owning a gaming asset that is net-leased to an operator. The opco-propco structure has definitely broadened the pool of potential investors in these properties,” agrees Simpson Thacher’s Ressa.

Post-pandemic resiliency

Casinos and gaming assets have different business models to other leisure-oriented hotel properties, and are, thus underwritten and benchmarked differently. For most hotels, rooms drive profits. The revenue stream for a gaming asset on the other hand, is significantly reliant on the casino floor, along with ancillary amenities such as food and beverages.

HWE’s Peek thinks casinos are like mousetraps. “They are hard to replicate,” he says. “The gaming activity, restaurants and surrounding shops do a good job of capturing customers and keeping them in place.”

That unique allure is one of several reasons Las Vegas casinos have remained afloat amid the uncharted waters of the pandemic. There was a period last year when casinos were shut and an eerie silence engulfed the otherwise bustling city, but business restrictions within southern Nevada’s hospitality sector gradually eased starting June 2020.

The recovery has been mixed so far, however. Gaming revenue totaled $1.25 billion year-to-date in February 2021, a 29.6 percent drop from 2020, according to Colliers data. The Las Vegas Strip was among the state’s most impacted sub-markets, recording a negative 42.7 percent gaming revenue growth, and a negative 52.2 percent room occupancy growth, during the same period.

Despite weak fundamentals, operators remained in a resilient cashflow position. Michael Parks, executive vice-president in CBRE’s global gaming group, says there has not been one gaming company that missed a lease payment on the Vegas Strip during this downturn, even during the initial shutdown of three to five months. Many casino operators, partially because of their sale-leaseback transactions, had healthy balance sheets and sufficient cash on hand.

“All these deal structures have a two-to-one rent coverage on the sale-leaseback,” he says. “The conservative nature of such arrangements helps in demonstrating how gaming assets are secure investments.”

The performance of the gaming REITs is also noteworthy, especially when compared with other property types.

“If you look across most real estate sectors, there was quite a bit of rent deferral and rent relief activity, especially in the net-lease space. The fact that MGP and VICI not only received 100 percent of their contractual rent but were also able to grow rent in 2020 spoke to the resiliency of that business,” says Green Street’s Balaguer.

“If covid-19 and forced closures cannot shake the profitability of your business and truly impact cashflows, it is hard to imagine the potential scenario where these landlords would experience cashflow volatility in any real way.”

VICI’s Pitoniak attributes this feat to his tenants’ operating excellence, strong balance sheets and the mission-critical element of the casino assets.

“The primary driver of our collecting rent throughout covid is that our operators got reopened and operated safely and very profitably in regional assets. Secondarily, these are not assets that, like so many other real estate categories, could be called white-box assets,” he says. “In other words, if a retailer wanted to play hardball with the landlord, it could point to an empty ‘white box’ a few doors down. Casino assets, by their nature, have a magnitude and customization that does not create many, if any, alternatives for the operator.”

Expected returns from gaming real estate, both in the private as well as public market, have also been higher than some other property sectors. According to Green Street data, the private market unlevered expected return for gaming is 7.5 percent, compared with 6.8 percent for single-family rental, 6.5 percent for lodging and 5.1 percent for offices.

All of these factors have contributed to the post-pandemic cap rate on a transaction like The Venetian not expanding in comparison to previous transactions. The Venetian’s 6.25 percent cap rate is understood to fall between the 5.75 percent cap rate on the Bellagio deal and the 6.35 percent cap rate on the MGM Grand and Mandalay Bay acquisition.

“While we are starting to see some compression on the cap rate on Vegas assets, it is still much higher than the 5 percent or lower yields being generated for trophy office buildings in markets like Manhattan and Los Angeles,” says Parks.

Betting on a comeback

Local casinos scattered across the country might not necessarily have the same scale in terms of deal size and institutional interest like Vegas, but managers focused on the space, such as New York-based Sculptor Capital Management, believe their cashflows are more stable than Vegas casinos in the current environment. Sculptor is focused on regional commercial and tribal casinos, and has in excess of 10 percent of its overall invested capital in this niche property sector.

Mark Schwartz, head of the firm’s gaming investments and head of North American real estate credit, says Las Vegas is a “fly-to” destination market versus local or regional casinos that are “drive-tos.”

“After the global financial crisis, revenues in markets like Las Vegas were down more significantly than the local markets. So, in some ways, Las Vegas is more correlated with macro-events and the GDP,” he says.

The other fundamental difference, from an investment perspective, is the unlimited competition in Vegas. “Anyone can open a casino in Vegas if you are licensed and spend enough money. In regional markets, however, there may be limited competition because of local regulations and that can help in keeping cashflows more stable.”

Those whose businesses rely on a Vegas rebound, however, remain optimistic. Some casino operators, for example, are already reporting an increase in occupancy levels from 2020. MGM Resorts International noted in a quarterly earning’s call in late April that total occupancy for its Vegas resorts was 46 percent between January to March 31, 2021, up from 38 percent during Q4 2020.

Bill Hornbuckle, MGM’s president and chief executive, pointed to the “robust leisure demand” anticipated for the spring and summer months, adding he expects weekend hotel occupancies to return to the 90 percent range soon.

The faster-than-expected recovery across several sub-categories of hotels, despite the sector once predicted to be one of the pandemic’s biggest casualties, is being driven by a fast pace of vaccinations and subsequent reduction in the number of covid cases across the country, leading analysts to predict a rosier travel outlook for the coming months.

“We are very bullish on the concept of revenge travel and believe there is a lot of pent-up demand for both business and leisure travel for Las Vegas,” says Green Street’s Balaguer.

Beyond the pandemic-tied recovery, gaming real estate investors are also keeping a hopeful eye out for an emerging secular tailwind; the continuing legalization of sports betting across the US. As of April 2021, 22 of 50 states had already made sports betting legal, while three others have recently passed bills to the same effect. VICI’s Pitoniak believes this will help operators in expanding their audience. Sports betting, in his view, presents an opportunity for operators to “increase gaming’s share of voice, which will in turn enable gaming to increase its share of mind, and increase its share of market within American consumer discretionary spending.”

Significant chunks of Las Vegas have recently changed hands. But much of the investment theses behind these recent transactions remains supported by one central belief: that gaming remains a relevant attraction for millions.