By Keith Loria, Contributing Editor
They say all things are big in Texas, and when it comes to the current state of multifamily rentals in Houston, Dallas and Austin, the numbers certainly live up to the billing. Last year saw tremendous growth for the Texas apartment market, and industry insiders expect 2014 to follow suit.
Ryan Reid, CBRE’s market leader for multifamily sales in Dallas, says “opportunity” is the buzz word in Texas.
“Most markets are performing very well, and job growth continues overall, which will continue to drive absorption,” he says. “Given the changing demographics of Baby Boomers and Gen Y, we continue to see strong demand for apartments. There is very good capital interest in the space given these factors that I believe provide opportunity for both buyers and sellers.”
In all three cities, “infill” and “core” are the words du jour. However, interest in a few select suburbs in Texas are rising, and that’s a trend expected to continue.
“Rent growth has been strongest in Austin, followed by Houston, but all Texas markets are seeing above-average rent growth,” says G. Ronald Witten, president of Witten Advisors LLC, Dallas, Texas. “Minor soft spots could emerge where there’s intense development in a very concentrated area, mostly urban, but nothing significant yet.”
Houston currently ranks as the country’s apartment demand leader by a sizable margin, having absorbed approximately 15,400 units during the past year. In comparison, Dallas registers annual demand of about 12,300 units, strong enough for No. 2 in the nation. Meanwhile, new industries and companies such as Facebook, Apple, Google and Visa are all driving job growth in Austin.
Todd McCulloch, Wood Partners’ director in the Dallas office, says that increasing land and construction costs are putting pressure on developers and putting a governor on new supply.
“The Houston job machine is in high gear, and as a result absorption has been strong,” McCulloch says. “Despite a high number of deliveries in the near term, we expect demand to outstrip supply. The story is similar in Dallas. Supply in Austin is a bit more of a concern given the city’s absolute size relative to Houston and Dallas, but the city’s apartment market is resilient and should be fine over the long term.”
Rents in all three cities continue to grow steadily, albeit at a somewhat slower rate than what has happened over the last couple of years.
“Vacancy has generally increased across the board, but that is merely a function of a disproportionate amount of deliveries in the near term,” he says. “Long-term fundamentals are good, and new supply should begin to abate somewhat as developers grapple with increasingly acute cost challenges.”
Strong employment growth has driven demand for both single-family and multi-family in the Houston area. Witten sees a dynamic economy driven by the nationwide and international energy boom.
“From drilling and production to services, to manufacturing, Houston companies are the experts,” he says. “They have a good runway ahead.”
Industry insiders suggest that in 2015, Houston’s apartment market will transition to a healthy equilibrium from a state of pent-up demand that seemed insatiable as the city exited the Great Recession. Apartment pricing has remained stable over the past year with core product trading either side of a 5 percent cap rate and older properties priced plus or minus 6 percent based upon particular characteristics.
According to data collected from Apartment Data Services, at the beginning of April the total inventory of Houston apartments was 577,256 units with an overall occupancy of 90.9 percent. In 2013, 16,135 units were absorbed which followed absorption of 14,629 units in 2012, 13,738 units in 2011 and 13,772 units in 2010.
“This strong performance reflects pent-up demand which built during the Great Recession,” says Hal Holliday, CBRE’s executive vice president in Houston. “Since the bottom of the downturn, the Houston Metro has added 371,000 net new jobs which equates to 241.5 percent of the 153,800 jobs lost during the recession. Houston created 80,100 jobs in the 12 months ending in March of this year and the unemployment rate was 5.2 percent, down from 6.1 percent a year earlier.”
By using job growth projections from Moody’s Analytics in forecasting demand CBRE predicts that in the three years (through 2016) 261,900 jobs will be created.
“We process that number into demand for apartments by applying Houston’s historically supported ratio of five new jobs correlating to one apartment unit absorbed and we also calculate demand at the more conservative ratio of 6:1,” Holliday says. “The resulting range of demand for 2014-16 is 43,650 to 52,380 units.”
On the supply side for those three years, 7,257 units have been delivered since January 1 and another 12,098 deliveries are expected in 2014 for a total of 19,355 with an additional 12,150 in the next two years.
“Balancing the supply/demand equation at 90 percent occupancy results in a forecasted need for 27,022 to 35,752 additional deliveries by 2016, which will come in part from the 16,057 proposed units. However, not every property on the current proposed list will or should be built, although it is a sure bet that other projects will be conceived,” Holliday says.
“The point of this exercise is that some observers of the Houston apartment market look at the many construction sites and cranes and worry that the market will be over supplied later this year and beyond, and they seem to forget that there are two sides to the supply/demand equation.”
However, a fact-supported forecast of demand clearly shows the need for more construction even if the job growth component of the demand forecast is assumed to be below Moody’s expectation.
Both land and construction costs have risen sharply in Houston in the past two years due to competition for good sites and the high volume of construction activity. It is reasonable to expect that rising costs will adversely impact the economic feasibility of some planned projects resulting in somewhat fewer new properties than may have otherwise been built.
“Even with strong demand on a macro basis, it is reasonable to expect spot rental concession in areas with a high number of deliveries,” Holliday says.
“The micro markets where concessions might occur are mostly desirable infill locations, and concessions will be of short duration,” he adds. “One reason for the concentration of deliveries in certain areas is that as the institutional equity investors returned to the apartment development market the mantra was ‘urban infill,’ and developers delivered.”
A look at Austin
Austin has been the quickest to recover after the recession as far as jobs go, with total employment now 13 percent ahead of the pre-recession peak.
“Job growth is still very strong in the area. It’s No. 2 of the 43 markets we follow nationwide at plus-3.9 percent year over year as of February,” Witten says. “It benefits from its traditional tech sector and appeals to young adults—the group most likely to choose to rent apartments.”
As a result of this, Austin is seeing a surge in new development.
“Starts have been slowing since hitting a peak in early 2013, which was the highest in absolute numbers since the 1980s boom,” Witten says. “This slowdown in starts should provide a soft landing, though.”
Patton Jones, principal with ARA, who works the Austin market says the key to Austin’s success has been job growth, and most apartments are operating at 95 percent, pushing rental rates upward.
“Right now, the fundamentals are excellent in Austin, meaning migration of roughly 15,000 people between 2012 and 2013, job growth of roughly 25,000 jobs, a very tight single-family market, low supply, and you have a strong environment for multifamily,” he says. “The concern people have on Austin is supply, and are we building too many units, particularly around the central business district urban core.”
Currently, deliveries have been slow to arrive due to construction delays, so getting things built has been a challenge as a result of labor and costs and a slow down with the city. What has delivered has leased very well and has seen strong rental rates.
“Properties are delivering slower than expected, which is healthy because it keeps too many properties from hitting the market at the same time,” Jones says. “It’s really hard to get a new construction deal financed today because of the concern of the supply pipeline. That tells me that I believe the supply pipeline is going to curve downward in late 2015, 2016 because of that caution. That’s really healthy for the market.”
As far as properties, urban infill remains very popular in Austin, with 65 percent of all new construction falling into this category. Jones says factors like urban walkability, the live-work environment and 24-hour living are also much in demand.
“East Austin is very popular. Six years ago, there was nothing new or exciting being built there, but today we have four to five mid-risers being built,” Jones says. “It’s a very hip, eclectic, cool location.”
Christopher K. Wong, vice president of debt & structured finance for CBRE in Dallas, says that for 2013, Dallas-Ft. Worth continued to see significant job growth, population growth and household formation, which translated into effective rental rate growth, tightening occupancies, strong demand and welcomed new supply.
“The Dallas-Ft. Worth area is projected to add over 100,000 jobs, and wages are expected to trend upward,” Wong says. “So, as a result, effective rental rates will continue to grow.”
According to Reid, Dallas continues to be very strong on the job growth front, plus the city has also become one of the more affordable markets in Texas given the rent disparity between Austin and Houston.
“The Toyota relocation from California this week is just another example of the strong employment story in DFW,” he says. “We will continue to see demand from corporate relocations which will bode well for the multifamily market.”
Most development in Dallas is occurring in the urban core as the younger generation wants to live in town where the night life and entertainment venues are all in walking distance. This has led to a number of companies relocating to downtown and uptown to attract talent.
The hottest area for multifamily development across Texas in 2013 was the Uptown/Oak Lawn/Highland Park submarket in Central Dallas, according to CBRE. Renters, particularly young professionals, are increasingly attracted to the “live-work-play” environment of the area. As a result, over 5,400 units are under construction in the submarket, more than any other submarket in Texas.
Marcus & Millichap’s Fourth Quarter Apartment Market Report reveals that asking rents in Dallas edged up, and the vacancy rates declined, creating a favorable context for multifamily to thrive. Effective rents climbed 4.1 percent to $861 per month in 2013, building on a 3.5 percent gain during the previous year.
According to a report by MPF Research, modest apartment demand in Dallas-Fort Worth during 2014’s 1st quarter did not keep pace with the high levels of new supply. In turn, occupancy dipped a bit but it was still very solid compared to the region’s historical norms.
Although not as robust as Austin or Houston, development in Dallas continues to be very active.
“Still, with U.S. recovery, the diversified DFW economy prospers and benefits indirectly from energy play and tech,” Witten says. “It’s a magnet for out-of-state companies seeking a low-cost, business-friendly Texas location.”
Throughout Texas there are strong institutional interest with cap rates back to, or more often below, mid-2000s levels.
“There’s lots of capital, particularly for ‘core’ transactions,” McCulloch says. “We haven’t seen any slip in cap rates over the last year despite the rise in Treasuries.”
Jones points out that Austin has always been a market where there are more buyers than sellers.
“It is a popular city, a strong economy, a large university, a popular music scene, so it’s a popular place to invest,” he says. “Currently, there isn’t a lot that comes to market at one time so when we do have a Class A property, it garners a lot of interest. Cap rates can be as low as 4 and a half percent.”
Dallas developers are expected to be the most active sellers in 2014, as they were in 2012 and 2013, according to analysis by CBRE. Private capital will maintain a strong presence on the buy side with institutional interest mainly focusing on more core infill product. The Dallas market has also seen new foreign capital sources coming in, and new high-net-worth family and office capital is becoming more prevalent.