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Houston Multifamily Occupancy, Rent Growth Return to Normal After Setbacks

Earlier this year, NorthMarq arranged acquisition financing for The Park at Clear Lake, a 342-unit multifamily community located on the southeastern side of the city. A balance sheet lender provided the loan, and the borrower will implement a value-add program. Deals such as this one reflect the easing of investors’ concerns, as oil prices stabilize and rates of absorption continue to rise.

Houston’s multifamily market has endured battles from all fronts in recent years: the oil slump, hurricanes, flooding, overbuilding in select submarkets, sluggish rent growth of late and lavish concessions to new renters that have been mainstays during this period. But the market now appears to be moving in the right direction with a sense of normalcy.

From late 2014, when the oil downturn began, through the price bottoming in early 2016, Houston’s energy economy consistently made headlines across the nation’s publications. Each article claimed that at lower oil prices, the city’s over-reliance on energy would shut off job creation and growth.

Yet this period also provided an opportunity to illuminate the incredible diversity within the greater Houston economy. Up until the oil downturn, the city’s diversity had been theoretical and unproven; now, along with the city’s resilience, it is indelible.

Warren Hitchcock, NorthMarq

Expanded activity at Port Houston, particularly in terms of manufacturing, in addition to plastics and petrochemicals, has propelled Houston’s job growth. The same applies to the market’s emerging role as a logistics hub and the expansion of the Texas Medical Center and regional healthcare providers, as well as strong growth in financial services and construction sectors. All told, the metro area added about 86,000 new jobs during the 12-month period between April 2018 and 2019, according to Greater Houston Partnership.

Multifamily investors have taken note of the economic diversification and ensuing job growth, coupled with natural in-migration and a relatively limited pipeline of new supply. In 2018, only 8,000 or so new units hit the market — a scant 1.7 percent of the total inventory. Absorption has been stronger with improved economic conditions in Houston, particularly in submarkets with limited new construction or where Hurricane Harvey reduced supply levels.

Due to these factors, Houston’s multifamily fundamentals have improved significantly since the oil slump began. The significant decrease in deliveries over the past year and absorption following Hurricane Harvey helped the market snap back to equilibrium.

Class A rents are seeing modest growth due to more supply coming on line and pressures on the renter-by-choice segment of the market. Class B rent growth of almost 2 percent has stemmed from the renter-by-necessity segment. Supply continues to dwindle and the discrepancy between Class A and B rents is expanding due to rising construction costs.

Landlords are beginning to burn off concessions and see stable levels of rent growth that can justify bringing their properties to market. The outlook remains favorable given the current, projected and diverse job growth in Houston. But an increasing supply of new construction and damaged units coming back on line could impact that outlook.

The Overall Market

According to Yardi Matrix, the average rent across all of Houston rose only 0.6 percent year-over-year through March 2019, severely lagging the 3.2 percent national growth rate. Occupancy in stabilized properties slid 140 basis points year-over-year to 92.4 percent as of February. Class B and C properties represent bright spots via the renter-by-necessity market and are seeing a strong wave of acquisitions and ensuing property improvements.

Population growth has facilitated a 1.7 percent increase in leasing volume over the same period. Another positive — new deliveries are down significantly from the 19,000 units delivered in both 2016 and 2017. Construction activity has been most concentrated in urban core submarkets like West End/Downtown (3,289 units) and East End (1,045 units), where average rents top $1,850 per month.

Strong job growth paired with targeted skill sets in fields like healthcare and manufacturing have a significant multiplier effect — each new job creates other jobs through redeployment of capital into the marketplace. As long as job growth is maintained, absorption of residential units should continue to increase, rents will grow and market fundamentals will continue to normalize.

Deal Volume Rises

Though Houston’s reversal of fortune has been more pronounced in certain submarkets, the elevated level of investment activity over the last 12 to 18 months indicates that buyers believe the market is moving in the right direction. In addition, investors are finding good opportunities to bolster returns through value-add plays, given that the market has a considerable supply of older construction.

In June, Blue Stone Premier Properties closed a portfolio acquisition of seven Houston apartment properties totaling 2,239 units, six of which were located within the urban core. In discussing the deal, Blue Stone CEO Randy Ferreira explicitly cited Houston as a critical market for his firm in 2019, noting that the portfolio’s unit count represented a large portion of his firm’s holdings of 5,800 units across six states.

Fort Worth-based Olympus Property Group has also been an active buyer of late in Houston. In May, the company acquired the 374-unit Tradewinds at Willowbrook, located on the city’s northwest side. Several months earlier, Olympus purchased the 260-unit Katy Ranch on the western outskirts of town.

While the Blue Stone transaction was a value-add play, Olympus has been targeting Class A product. But collectively, the deals reflect how the market is fielding demand from different types of capital sources for different types of assets. Encouraged by investors’ renewed appetite for the product type, multifamily developers are green-lighting more new projects in expectation of being able to achieve healthier rents.

As deal volume rises, lenders are fielding more competition for deals, tightening spreads to rates below 4 percent, even as low as 3.5 percent for a 10-year term on the right deal.

Lenders are also looking for opportunities to aggressively widen their spreads in a yield-hungry environment as interest rate yields continue to drop. The opportunity to chase higher yields on value-add assets — especially multifamily — has all classes of lenders entering the space on proven value-creation plays.

Final Thoughts

As occupancies stabilize, we see valuations on select assets hitting record levels. On deals for older properties, price-per-unit valuations are close to the estimated costs of replacement construction. On the flip side, investors remain wary of the Federal Reserve’s about-face on monetary policy and are currently waiting for more clarity on where rates are headed.  Finally, one of the largest concerns locally is the impact to valuations and cash flows from more and more aggressive property tax assessments.

All things equal, the market is in considerably better shape than it was at the beginning of the oil bust. Above all else, the perceived level of risk that multifamily investors see in this market has declined substantially. Though we are presumably close to the end of the current economic expansion, Houston’s economic and demographic fundamentals suggest that this particular market is well-equipped to weather another cyclical trough.

— By Warren Hitchcock, senior vice president, NorthMarq. This article first appeared in the July 2019 issue of Texas Real Estate Business magazine. 

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