Vice and virtue in Miami

Though it might not seem so today, the city of Miami—home of the Versace Mansion, South Beach dress codes and Don Johnson in a pink tshirt— has not always been a hotbed of excess and optimism. In the early 1500s, the Spanish explorer Ponce de Leon was so thoroughly repelled by the local natives that he went off in search of the Fountain of Youth, presumably an easier target. More than three centuries later, the region was no more hospitable: a series of brutal wars between the US government and the Native American Seminole tribe effectively wiped out the local population.

It wasn't until the 1920s that Miami finally found the keys to prosperity: gambling and alcohol. By turning a blind eye to Prohibition and anti-gaming laws, city officials were able to attract a steady stream of Northerners eager for sun, sin and a tumbler of rum. The spirit of the Jazz Age was even more conspicuous in the local real estate market, where the soaring population spurred construction and led to the advent of the now-familiar Miami high-rise—in less than a decade, a new skyline had emerged on the shores of the Atlantic. Unfortunately for speculators, the Great Miami Hurricane of 1926 abruptly ended the party.

Today, Miami is once again in the throes of a property boom. This time, the intoxicant of choice is cheap financing—and not even a hurricane has been able to slow it down. In December, two months after Hurricane Wilma hit the city, Miami's planning department released figures showing that the number of condominiums under construction had actually increased since October, from 14,000 units to 15,000 units; the number either approved for development or applying for a permit also went up, from 63,000 to 67,000 at the end of the year. By comparison, around 11,000 units were built in Miami in the past decade.

Perhaps understandably, private equity real estate firms now view Miami in much the same way as de Leon: a land of mortal danger. At industry conferences (which, incidentally, seem to appear more frequently than construction cranes on South Beach) opportunity fund managers are quick to disparage the condo converters and fly-by-night capital flooding South Florida. Two general partners I recently spoke with predicted that most of the condos under consideration would never even be built.

A recent rip to Miami provided enough evidence to justify the trepidation. Across the city from the Design District to Biscayne Bay construction cranes dotted the sky. In South Beach, a real estate sales office advertising million-dollar condos sat adjacent to another sales office advertising million-dollar luxury yachts. And at high-end furniture stores on Lincoln Road, the coffee-tables weren't decorated with art and design books, but rather with magazines advertising new condominiums. Caveat emptor.

But positive signs also emerged. For one thing, Miami has something that its condo-obsessed twin Las Vegas does not: culture. After a weekend in Sin City, most people are more than ready to leave; after two days in Miami, one wonders why you would ever want to. As Irwin Molasky, a Las Vegas developer recently told the Wall Street Journal, “[Las Vegas] is not New York. This is not Miami. We are still in the desert.”

Nevertheless, even New York lacks Miami's best quality: good weather. Not to mention relative affordability. According to figures from the Miami Herald, the average price for a two-bedroom, 1,400 squarefoot condo in Miami is 70 percent less than a comparable one in the Big Apple. Even cities such as Chicago, Seattle and Atlanta are pricier. Put it all together and perhaps it's not surprising that the US Census predicts that Florida will become the third most populous state in the country by the next decade.

The furor surrounding Miami may say more about the structure of private equity real estate funds than it does about the action on the ground. In the short-term, a downturn in the Miami housing market is almost a certainty. But over the long-term, even the most pessimistic of investors would have to be bullish on the city's viability. Yet a private equity partnership, an excellent vehicle for motivating GPs over a 3 to 5 year time frame, doesn't easily lend itself to long-term value creation. Institutional investors can afford to wait until 2030. Private equity real estate funds cannot.

But anyone interested in the potential for profits in Miami would do well to consider this: the governor of Florida recently loosened gaming restrictions for Indian casinos in Broward and Miami-Dade counties. A change in political leadership could bring even more liberal gambling laws. The sun and sea of Miami combined with the thrill of Las Vegas? That seems a bet any real estate investor would be happy to make.