Past Peak

By Philip Shea, Associate Editor

After a period of historically strong performance in nearly every fundamental, Texas’ apartment industry is finding an equilibrium just below its post-recession crests. With rent growth beginning to slow and concessions returning to the market, many developers and investors are treading more cautiously and focusing more squarely on niches they know will generate returns.

Bill Jackson, senior vice president and managing director, NorthMarq Capital, says that his Dallas office has focused mostly on the Lone Star State’s four major markets—Dallas, Houston, Austin and San Antonio—over the last few years. He notes that while these areas will continue to be bastions for many types of growth—urban infill and suburban—some of the smaller markets once sought for development are now returning to their pre-recession statuses.

“I think the multifamily markets have been strong in all the major markets in Texas,” says Jackson. “Although there is some thought that some submarkets are getting plenty of attention, there are other submarkets that are getting no attention, so it’s sort of a lumpy pipeline where the properties are actually getting built because of the desire of the equity and where they want to go.”

This point is complemented by Jay Parsons, national market analysis manager for MPF Research, who adds that while the four major markets continue to be the state’s reliable areas for growth, there have been dynamic shifts within these occurring side-by-side with the larger shifts noted by Jackson.

“What’s interesting is that, coming out of the recession, what we saw was that Austin and Dallas were really the frontrunners,” says Parsons. “Then we’ve seen in the past year or so, Houston—which was surprisingly slow given the strong job growth over there—has really picked up. San Antonio’s also picked up, to some degree.”

Parsons adds that the reason Texas overall is past peak performance levels has to do with the unique nature of the state’s position during the recession—having been immune to some of its worst effects—and new trends in supply and demand that can be seen in other regions as well.

“There are a few things going on here that are causing a slowdown in occupancy growth. One is simply that Texas was an early recovery state, so we started to see occupancy get pretty high by Texas standards to the point that it really couldn’t get any higher,” says Parsons. “The other part is we’ve seen a lot of apartment construction… and we’re starting to see more loss of renters to home purchases as well.”

Indeed, the latter part of this trend is not entirely specific to Texas. In a recent report entitled “From Bullish to Balanced: A Changing View of the U.S. Apartment Market,” Prudential Real Estate Investors (PREI) notes that while apartments have been the best-performing segment of the real estate market since the downturn, a big part of this had to do with a lack of new construction from 2009 to 2011, which took off shortly thereafter.

“New supply of both single-family and multifamily housing has been extremely limited in recent years, as credit from banks largely dried up, and developers faced mounting financial difficulties,” the report states. “But the improving capital markets and favorable apartment dynamics have spurred renewed development activity slated for the rental market.”

The report goes on to state that, like in Texas, multifamily nationwide is likely to remain strong due to the fact that “continued population growth and strong demographic trends within key apartment renting age groups” are expected to continue for the foreseeable future.

In terms of which types of investments will bear the most fruit in the short term, Jackson notes that there is still considerable potential in the renovation of older product as opposed to brand new urban infill that has taken the four major Texas markets by storm.

“Certainly there’s a tremendous opportunity if you can find these deals that are in an A location but they’re a B or C product, [and] you can upgrade,” says Jackson. “So there’s quite a bit of that type of investment activity going on in the ‘80s and ‘90s vintage-type stuff.”

However, with respect to urban infill, Jackson points out two locales that continue to generate the most activity and thus investor interest—even as other submarkets begin to see similar trends in development.

“I think as you look around Texas, the downtown Austin and the Uptown Dallas market are two walkable neighborhoods that apartment dwellers really like,” says Jackson. “You’ve got the Alamo-Manhattan guys, you’ve got the City Lights guys, you’ve got the Forest City guys… you’ve got all the big guys in the Uptown area that are building high-end properties.”

Looking at the other top-tier markets, Parsons points out one particular niche that has yet to be fully capitalized upon and is likely to generate great results based on demographic trends over the last few years.

“I think with San Antonio there is a lot of opportunity in that Class A segment of the urban core, just because there isn’t much there yet,” says Parsons. “But it’s such a growing market. The median age in San Antonio is young, there are a bunch of educated adults moving to San Antonio—so I think there is a lot of potential in that urban core development and investment.”

With regard to the younger demographic, PREI notes in its report that as of right now nearly 31 percent of adults ages 20 to 34 live at home, and that this is still three percent higher than the long-term average.

“An additional two million renters could be created if that number were to revert to its long-term average of 28 percent,” the report states. “In all likelihood, the demand created would total less than two million units since many people don’t live alone, but job growth that moves young adults away from parents would certainly produce a substantial need for rental units.”

Hoping that this and other factors do come into alignment, Jackson notes that Texas’ real estate industry—as with others across the country—has relied in large part upon very favorable lending conditions and interest rates. Yet as the overall economy begins to improve, this may cease to be an ample linchpin—increasing the weight of other factors.

“The availability of competitively priced long-term debt is the best it’s ever been,” says Jackson. “We’re making loans at rates I’ve never seen, and I think we all hope it will last for a long time, but there are some storm clouds out there that seem to indicate that may not last forever.”

Yet harking back to the unique position of his state, Parsons notes that Texas has a tailwind—that other regions of the country do not—as favorable banking conditions begin to dwindle and the recession gets smaller in the rearview mirror.

“With the jobs as they are, Texas is drawing a lot of people from outside the state,” notes Parsons. “I can tell you that we hear a lot about people coming from California and the Northeast, particularly young adults getting out of college—they go where the jobs are. So the economy and demographics are the biggest drivers for sure.”