John Reichenbach, Capital One
Success breeds success. That adage, more than any other, defines the Dallas-Fort Worth economy and its strong multifamily market. In the last five years, a number of companies, such as Toyota North America and Nationstar Mortgage, impressed by the advantages of doing business in Dallas-Fort Worth, have relocated their headquarters here.
These companies were attracted by the area’s central location, equidistant from both coasts, as well as an educated workforce, a diverse economy and a favorable business climate. This year Jamba Juice, among other companies, took notice and announced that they are joining the migration to north Texas.
Cathy Janke, Capital One
Even companies not choosing to uproot their headquarters are expanding their presence in Dallas-Fort Worth. Early this year, JPMorgan Chase picked Plano’s Legacy West development for a new 6,000-employee campus, next door to Toyota as well as Liberty Mutual, which itself will add 5,000 workers to a huge new service center it is building there. Also this year, Fannie Mae announced it would move more than 1,000 workers to Plano, the medical giant McKesson revealed plans to add 1,000 office jobs in Irving and Pegasus Foods chose Rockwall for a new plant that will employ 300.
The Federal Reserve Bank of Dallas’ Business Cycle Index shows annual overall economic growth as of July 2016 of 4.3 percent in Dallas and 2.3 percent in Fort Worth.
Growth Sustains Multifamily
Not surprisingly, the strong, growing economy has energized the multifamily industry. There are 25,900 new apartments scheduled for delivery to the market this year — more than in New York City, according to Yardi Matrix data — but even at this level of construction the market remains relatively tight.
The Dallas Fed notes that rent growth continues to be strong and apartment occupancy high despite elevated construction. Over the last year, the vacancy rate has hovered around 5 percent, and as of July, rents were growing at a 5.1 percent annual pace, according to Axiometrics.
If multifamily construction is slowing, it is tapering gradually. During the first half of 2016, 9,706 apartment permits were issued, a number comparable to the 9,697 issued over the same period in 2015. Notwithstanding, banks have become more selective about construction lending, responding to higher capital requirements under Basel III and High Volatility Commercial Real Estate (HVCRE). In spite of this pullback, seasoned and well capitalized developers — especially those with a record of high-end projects in core areas — are not having any difficulty sourcing construction financing.
To cite just a few examples, Phoenix-based RED Development officially kicked off construction this past spring on The Union Dallas, an 800,000 square foot office, residential and retail project located a block north of downtown near Victory Park. The two-tower, mixed-use project is slated to include 417,000 square feet of Class A office space, 309 luxury apartments and 87,000 square feet of retail space.
Joint venture partners Trammell Crow Co. and MetLife announced the start of construction on their Park District project at the beginning of 2016. Located in the heart of Downtown Dallas, the two-tower mixed-use project includes over 900,000 square feet of Class A office, residences and retail space.
The sustained high level of investor interest demonstrates that Dallas-Fort Worth is not overbuilt. Institutional funds and REITs, historically focused on upscale properties in premier markets, have joined the pursuit of value-add projects, an investment realm previously dominated by private investors.
McCann Realty Partners’ recent purchase of the 165-unit Marquis on Cedar Springs typifies this strategy. This 15-year-old mid-rise is in the exclusive Turtle Creek neighborhood, which is bordered by the high-end residential neighborhoods of Highland Park and University Park to the north and Uptown and Downtown Dallas to the south. McCann plans to upgrade the interior finishes, amenities and clubhouse, rebrand the apartment as Radius Turtle Creek and reposition the community.
Acing The Houston Test
One way to appreciate the strength of the Dallas-Fort Worth economy and multifamily market is to subject it to a thought experiment that could be called the Houston Test. While Dallas-Fort Worth flourishes, Houston has struggled for the last two years under the weight of a dramatically restructured oil market.
Thanks to the diversification it achieved over the years, Houston is weathering the drop in oil prices more successfully than during the oil glut of the early 1980s, but the drag on its economy is nonetheless undeniable. According to the Dallas Federal Reserve, the Metro Business Cycle Index for Houston dropped to an annualized rate of negative 3.7 percent in June, unemployment rose 0.7 percent to 5.5 percent, and job growth rose at just 0.2 percent annually, or 5,200 jobs.
During the same time period, area builders delivered 12,000 apartments, with 31,000 under construction. By the time these apartments are ready to welcome tenants, vacancy rates will be approaching 7 percent. Would something similar happen to Dallas’ multifamily market if there were an analogous shock to its economy?
The easy answer is that the Dallas-Fort Worth economy is so diversified that a disruption to any of these sectors would have only muted effect.
For one thing, demand for the next few years, in the form of new headquarters and regional centers, is providing a cushion. It will take until 2018 at least before the last of the out-of-town employees settle into their new corporate campuses, and in the interim, developers would have the time to put potential projects on hold.
Any slowdown would also cause minimal dislocation for investors. Apartment valuations have increased much more modestly than on the two coasts. There has been an inflow of foreign capital into Dallas-Fort Worth, but it is nowhere near as influential as in Los Angeles or New York. The result? Although there has been some cap rate compression, rates are now generally in the 5 to 6 percent range. If foreign capital withdraws in response to a local shock of some sort, the effect on the Dallas-Fort Worth multifamily market should be minimal.
The thought experiment indicates that the Dallas-Fort Worth multifamily market will likely slow gradually in the near term should there be a disruption. In the long term, the strength of the market’s underlying fundamentals, such as its diversified economy, central location, educated workforce and pro-business environment, suggests that Dallas-Fort Worth will not easily be deflected from the upward trajectory it has attained over the last few years.
— By John Reichenbach and Cathy Janke, senior vice presidents with Capital One. This article originally appeared in the October 2016 issue of Texas Real Estate Business.