Lone Star State

The last few months of 2008 saw a rapid evaporation of the momentum gathered earlier in the year. The overall Texas occupancy average ended the year at 88.5 percent, down 160 basis points from year-end 2007. For individual markets, the Dallas market fared best in occupancy and ended the year at 89.1 percent, falling 180 basis points from 90.9 percent in December 2007. Houston held steady for 2008, losing only 10 basis points of occupancy, falling from 88.3 percent to 88.2 percent. The largest drop occurred in Austin, where 2007 ended at 93.7 percent and 2008 wrapped up at 89.0 percent—a 470 basis point drop.Market rents in Texas moved in a positive direction during 2008. The state posted an increase of 3.2 percent in rents, with Houston leading at 5.3 percent growth—partly because almost one percent of the MSA’s (Metropolitan Statistical Area’s) inventory was sidelined by Hurricane Ike earlier that year. Austin had strong market rent growth as well, finishing the year at $881, from $842 in December 2007. This rise of $39, or 4.6 percent, represents the highest market rents in Texas. San Antonio lost 170 occupancy basis points during 2008, finishing at 88.4 percent, and increased market rents by 3 percent to $731. Fort Worth saw similar activity, with occupancy dropping 200 basis points and market rents moving up 1.8 percent to $738. The Dallas area was able to raise market rents 2.2 percent, or $17, from $786 to $803 for 2008.Dallas/Ft. Worth’s favorable conditionsWith the national recession in full swing, the Dallas/Fort Worth Metroplex might be the best place to ride it out. The Bureau of Labor Statistics reported that 31,000 jobs were created in 2008. While this number certainly will be revised downward, the net job creation number should remain above zero—and in today’s market that’s good news. In 2008, some job creation for the area was announced, but it was quickly followed by layoffs. For example, in mid-2008, AT&T announced relocation of 700 jobs to the Metroplex, then later announced a reduction in jobs nationwide. AT&T is the second largest employer in the MSA, so this will have some effect moving forward.While all industries are feeling the effects of current market conditions, Dallas/Ft. Worth’s distribution of jobs across a wide range of disciplines is favorable for the area. The positive household formation and a younger demographic combine to bode well for apartments in current and future years.According to M|PF Yieldstar, for 2008, apartment absorption finished in negative territory, with 5,580 move-outs—all in the fourth quarter—while the first three quarters were essentially flat, recording only 290 net move-ins. With this negative apartment absorption, revised job growth numbers surely will be lower than the initial estimates.Single-family building has fallen off by more than one-half from 12 months ago (driven by sales falling by more than two-thirds), but multifamily construction continues to see significant deliveries in 2009. As of March 1, 2009, more than 15,000 units were under construction in Dallas/Ft. Worth and scheduled for delivery through year-end. A drastic drop-off in starts should occur in 2010, as only 4,000 units appear to have secured construction financing.Looking ahead to 2011, the development pipeline may base at record-setting low levels not seen since the late 1980s. After these deals are delivered, though, a few years should follow with almost no new units brought to market. As developers put the brakes on pre-development, the gap in deliveries will allow current inventory to be absorbed and occupancy to tighten. This gap also will allow developers to revise plans and possibly develop new design characteristics—creating a new “A” class of product. In the late 1980s, the construction gap segregated the “A” product from the “B” product through the introduction of nine-foot ceilings. This time, either 10-foot ceilings, better soundproofing insulation, or the “green apartment” may define the new “A” product. If the job loss path continues and 2009 numbers are flat or worse, absorption of new units will be lackluster, at best. The new product coming on line will be heavily marketed and concession-driven, and rents will fall to a level that actually puts “heads on beds.” When rent growth vanished in fourth quarter 2008, falling slightly into negative territory, apartment communities offering concessions increased. This marks a change from the strong rent growth of about 4 percent annually for the previous eight quarters. Fourth quarter 2008 rent concessions increased 25 percent year-over- year, resulting in half of all properties offering concessions upon move-in. Other economic factorsThe North Texas region didn’t have the drastic run-up in home prices in recent years that other U.S. markets experienced, so the single-family market has held up relatively speaking, with only an 8 percent price decline. Pricing was also held in check by the drop in construction activity throughout the area. In addition, the condominium craze did not have a large market share of development. Failed condominium developments reverting to the rental pool were extremely limited, with our data showing four to five developments—fewer than 1,000 units—making the transition to rentals. The single-family home “shadow market” is often mentioned as a competitor to professionally managed apartment communities. Clear evidence of significant multifamily rental losses to vacant homes has not been substantiated. The fragmented single-family offerings, scattered nature of the product, and issues of maintenance, insurance, and capital needs may temper the ultimate demand for single-family homes by “professional renters.”The investment market still likes certainty and predictability from the government. With government’s role escalating daily and the fluctuating money going to loan guarantees and stock purchases, the market is hesitant to make any long-term commitments or decisions. Once the government commits to a plan and brings clarity to the amounts headed to each industry, the market will price those commitments, and distressed funds will begin the process of moving the vast amount of transactions that must be transferred from bank balance sheets and TARP programs into the private sector. Most buyers and sellers are in a “wait and see” mode. Sellers are hesitant to dispose of product in a down market, and buyers are reluctant to purchase if they think the price will continue to drop. Eventually, though, buyers will take the risk based on simply underwriting the properties’ current initial stream of cash flows and the return they generate based on the risk-adjusted return on other investment opportunities. With the downside of generating an attractive initial yield on cost and not betting on large “back-end” weighted financial returns, cap rates are approaching a level where buyers will enter the market.The current financial carnage, while virtually halting all transactions, will present the deepest and most fundamental buying opportunity since 1990. Cap rates will reflect positive leverage based on deliverable debt. Required equity will escalate. Current cash flow will be a reality and sustainable. The glory days of financial engineering and maximum leverage have ended.Tom Flood is executive vice president and Mark Johnson is associate at Colliers International’s Multi-Family Advisory Group.