New Las Vegas resorts a luxury companies can’t afford

By Liz Benston

Monday, March 15, 2010 | 2 a.m.

Harrah’s Entertainment is spending about $100 million to buy the Planet Hollywood resort from a nearly bankrupt neighbor and reinvest more money into the property.

It spent $60 million to build five posh swimming pools that open Friday at Caesars Palace. Three other pools there were upgraded last year.

Yet Harrah’s is holding off on spending $85 million to finish a half-built luxury hotel tower at Caesars that will remain empty until business improves in Las Vegas.

Up the Strip, Wynn Resorts is spending $67 million on a nightclub and “beach club” and will renovate a nearby restaurant to serve these venues.

But the solid consensus is that no new casinos or hotels will be built on the Strip any time soon, and the timetable for finishing partially built ones is up in the air.

Developers have shelved plans for billions of dollars’ worth of resorts on the Strip, including Boyd Gaming’s Echelon, El Ad’s megaresort version of New York’s Plaza Hotel, an Elvis-themed resort at the site of the Hawaiian Marketplace and a megaresort at the site formerly occupied by the Wet ‘n’ Wild water park.

So what makes a pool or restaurant worth opening in the midst of a recession but a new Strip resort or hotel expansion a terrible idea? It’s not that casinos, in and of themselves, are the problem. After all, Steve Wynn wants to invest $250 million in a Philadelphia casino under development. And his competitor Las Vegas Sands — which already has a Pennsylvania casino — is lobbying to build a Las Vegas-style resort in Florida. So what makes Las Vegas casino owners swear off new resorts in their hometowns for developments in other parts of the world?

The answer is the Strip’s return on investment, which is, at its most basic, what a project earns divided by its cost. This equation, which drives business decisions in any industry, best explains why developers won’t be building hotels or casino resorts in Las Vegas for years to come.

Revenue generated by major Strip operators fell up to 21 percent last year and earnings fell by up to 37 percent. Returns for new projects — especially Encore, which opened in the midst of the recession and which has a year of operations under its belt — is close to zero.

That’s a dramatic change. In the early 1990s, new projects in Las Vegas generated returns in the 20 percent range, peaking at 29 percent in 1993, according to an analysis by casino consulting firm Union Gaming Group. Returns were sliding in the teens by the year 2000, plummeting to an all-time low of 5 percent in fiscal year 2009.

New properties increased competition in Las Vegas but also helped the market by attracting first-time visitors. That trick has become harder to pull off with the limited number of visitors able to afford the Strip’s increasing number of higher-end hotels. It’s even more difficult to do in a recession.

But that’s only part of the equation.

The cost to build new resorts exploded during the construction boom and is still relatively high considering the lack of demand.

Even before the recession, increased competition had diminished returns for Strip resorts from the early 1990s, which represent the first major building cycle in the modern resort era.

And yet, casino operators continued to build new properties.

After all, returns in the midteens — compared with single digit returns in other, more saturated industries like retail — looked pretty good. Operators also hoped to attract new customers to Las Vegas with additional high-end resorts rather than by simply stealing existing business from mid- or low-rent competitors. And they succeeded — to a point.

According to Union Gaming Group, returns hovered around 13 to 14 percent from fiscal year 2004 through fiscal year 2007 — when visitor volume and overall business soared to historic highs.

For a time, operators were happy to get 15 percent returns. Those returns quickly became obsolete at the first hint of a downturn, as analysts, before the recession, had expressed early concerns about whether there were enough well-heeled visitors to fill thousands of luxury hotel rooms set to open on the Strip. Now, operators are lucky to get single-digit returns on new projects.

Returns for the $8.5 billion CityCenter complex — if the project meets post-recession earnings expectations — are expected to be in the single digits, analysts say.

So while casino operators haven’t given up on spending money in the recession, they are allocating fewer dollars.

Recent expenditures by the likes of Wynn and Harrah’s make sense, despite the downturn, because they have the potential to boost lackluster returns for their owners, argues Bill Lerner, a principal with Union Gaming Group.

Acquiring Planet Hollywood will allow Harrah’s a chance to capture a bigger share of Las Vegas visitors’ budgets, including regulars at Harrah’s casinos outside of Nevada who rack up points using the company’s gambler loyalty program and who don’t always spend money at Harrah’s-owned casinos on the Strip, he said. The resort is the first new Harrah’s-owned property in Las Vegas since Harrah’s bought Caesars Palace and other Caesars-owned casinos in 2005.

“They know people come to Vegas anyway and don’t necessarily stay with them because they want variety. This (resort) gives them another option in Vegas,” Lerner says.

The new venues at Encore will help the resort generate incremental returns by capitalizing on the high-profit nightclub scene, he says. That could help the property keep the business it already has, potentially steal business from competitors and perhaps even help the market by attracting new Las Vegas visitors who partake in the party scene at other posh hotels, Lerner explains.

Some pundits say it could take five years before earnings catch up with the billions that operators have invested in new resorts and other offerings in recent years. Others say it could take at least a decade before demand is absorbed, opening the door for new properties.

In the meantime, a lack of demand for new resorts plus high construction and financing costs equals a negligible return on investment, Lerner says.

“The numbers just don’t work,” he says.