By Taylor Williams
From sprawling garden-style complexes in the suburbs to wrap-style construction and high-rise buildings in the urban core, multifamily properties come in many shapes and sizes. And in Texas, all of these product types are in high demand.
Consequently, developers have generally seen healthy paces of rent growth over the last decade. But with each year of cyclical maturation, land becomes more scarce, construction grows more costly and more communities come on line, making the competition to secure renters increasingly stiff.
On a more granular level, bidding wars for large tracts of land that can support major residential density are becoming increasingly intense with the growth of build-to-rent (BTR) development throughout Texas. Global supply chain disruption is putting relentless pressure on costs of construction materials and timelines for new projects, and leasing initiatives are getting smarter via sophisticated proptech platforms that were developed exclusively with real estate operations in mind.
But these economic and operational constraints exist entirely on the supply side of the market. Simultaneously, demand for housing is accelerating unencumbered throughout Texas, a perennial medalist in population growth among the 50 states.
These market factors are creating an unusual dynamic in which the forces that drive revenue and costs of multifamily development are moving at frenetic paces toward the extreme ends of those spectrums. It’s just a question of which side will bend — or break — first.
“Competition in Texas is extremely strong across all rental product types, be it single-family rental, traditional apartments or other forms, such as seniors housing,” says Gabe Lerner, managing director at Houston-based Allied Orion Group. “This is due to the desire to relocate to Texas from out of state and, from people living here, to continue to enjoy a low cost of living option with great job opportunities that are abundant throughout Texas.”
Allied Orion Group recently broke ground on Evergreen at Whisper Valley, a 350-unit development that will be situated within Taurus Investments’ Whisper Valley master-planned community in Austin. The property’s location within the larger, 2,067-acre development creates a built-in advantage in terms of available land for other uses — residents have access to a 600-acre public park and nature preserve with hiking trails.
“From a land-cost perspective, everything in Texas is hot, and sellers are asking for top dollar,” says Lerner. “Even experienced developers are being forced to get creative in taking down land at prices that still make sense with construction costs. Each submarket has its own story to tell on pricing and growth, but in general, garden-style and mid-rise product are more sensitive to land costs. Thus, the negotiation on pricing for dirt is extremely important for our yield.”
To these ends, developers have to be exceptionally mindful of what subcategory of multifamily product they deliver, based on the existing supply-demand balance within a certain submarket. For developers that have the capability and experience to build multiple product types, nailing that decision starts with having access to good data.
“In this environment, rents and costs move incredibly quickly, but we still have to prepare budgets and explain those projections when we raise debt and equity,” says Ben Browder, vice president of development at Austin-based OHT Partners. “So having access to good information on what specific materials cost, as well as updated numbers on rents and sales comps, is beyond critical.”
Performing this type of due diligence is an integral part in the predevelopment process, but it’s only part of the puzzle, Browder adds. The next step involves carefully scrutinizing the prospective acreage and understanding what kind of density it can support — as well as how much competition for that specific product type already
exists.
“We’re not going to put a podium project in a cornfield; the economics just don’t make sense,” he explains. “A garden-style product will take up more acreage than a podium project but will also be cheaper [to acquire] on a per-square-foot basis. We also have to make sure that we buy the land correctly, so we rely a lot on brokers to ensure that we’re paying fair market prices.”
OHT Partners recently began construction on Lenox Grand, a 315-unit, garden-style project located near The Domain in North Austin. According to Browder, OHT Partners opted for garden-style product on this project because it lowered construction costs and offered a competitive advantage among future residents who prefer lower-density communities with more green space and surface parking.
“Wood framing and surface parking make garden-style communities more cost-effective to build compared to wrap-style communities or podium construction,” Browder explains. “Wrap-style apartments feature multiple stories of apartments wrapped around a concrete parking garage, while podium projects have multiple stories of wood-framed apartments that sit on top of a podium made of concrete. The podium is often utilized for parking and is sometimes used for other commercial uses such as ground-floor retail.”
Supply Chain Woes
But regardless of size, location or style, all multifamily projects require many of the same basic materials. Given the ongoing severity of global supply chain snarls, all developers are competing for limited quantities of these materials, which suppliers are often forced to ration out. Limited allotments translate to higher prices.
Against that backdrop, the decision of which product type to build becomes even more important, says Kip Sowden, chairman and CEO of Dallas-based RREAF Holdings.
“Generally speaking, in this environment, for a two- or three-story garden-style multifamily project, you’re looking at anywhere from 23 to 28 percent higher construction costs versus 18 months ago,” says Sowden. “For podium-style, wrap projects, it could be as much as 35 to 40 percent more. So before going into any market, you’ve got to do tremendous due diligence on demand, clientele profile and achievable rents for that product type.”
RREAF Holdings recently acquired nearly 3,300 acres in Midlothian, a southern suburb of Dallas, for the development of a master-planned community that will offer single-family homes, townhouses, BTR and multifamily units, as well as two schools and a town center. The project speaks to the company’s strategy of diversifying its offerings of residential product types, including the BTR segment.
“These BTR communities are really nothing more than deconstructed multifamily projects,” says Sowden. “We’re seeing big capital come into that space, and there’s a growing segment of the population that doesn’t want to own a single-family home but does want to live in one. And that segment is on fire.”
“As inflation increases, there will be more pressure to sustain the rental rates needed to support new development,” Sowden continues. “But in Texas, demand still exceeds supply in most markets due to in-migration. Coupled with the investment demand for multifamily and the abundance of capital chasing those deals and pushing cap rates to new lows, it still makes sense to develop, even with the current challenges in the supply chain and the growing cost of building supplies and labor.”
Houston-based developer BHW Capital focuses on projects in suburban settings with aesthetics and amenities comparable to more urban locations. Access to major thoroughfares and employment hubs are also major considerations. The firm recently broke ground on Park on Napoli, a 239-unit community in the Vintage Park submarket on Houston’s northwest side. Matt Bronstein, vice president at BHW Capital, provided some anecdotal evidence of how supply chain disruption is impacting that specific project.
“Park on Napoli is a flat-roof project with TPO roofing; our general contractor placed the order with the supplier months before construction began, and we still could not get some of the components,” he says. “It became necessary to find equal substitutive products to deliver a fully functional roofing system on time. Everybody is escalating their ordering time frames, but suppliers’ hands are tied.”
“In this market, manufacturers can engage in just-in-time delivery and not have to warehouse their goods, which allows them to better control pricing and in some instances raise prices when they want to,” Bronstein continues. “Anywhere from 25 to 30 percent price increases on a product year-over-year is not uncommon these days; we’ve seen it across the board on everything from building materials to fitness equipment.”
Because the narrative of global supply chain disruption is well-documented in mainstream news, multifamily lenders and investors on new projects are generally aware and understanding of these price hikes. But even so, Bronstein says that maintaining regular and open lines of communications with capital sources and investors is essential.
“We have to be in constant communication with our general contractor to keep our finger on the pulse of costs,” he says. “Properly evaluating new deals and being able to explain to debt and equity sources what’s going on in the market is critical to managing risk. But prices move so quickly that it can be very challenging.”
Inflation Complications
As if accurately forecasting demographic information, winning battles for coveted sites and correctly choosing the right type of product to build weren’t difficult enough, sources note that the multifamily development process is further complicated by another economic variable: inflation.
The Consumer Price Index (CPI), which tracks aggregate increases in pricing of U.S. goods and services, registered a 7.6 percent year-over-year increase in January, the highest such mark in 40 years. Developers’ costs are rising, increasing their need for higher rates, while at the same time, renters’ disposable incomes are being stretched.
Yet these two opposing forces must find some sort of middle ground.
“Affordability is a growing challenge in Austin,” says Browder of OHT Partners. “We’re sensitive to that and do what we can to add housing and address the root of the problem. Ultimately, however, prices are set by the market, and in the multifamily industry, that often comes down to specific submarkets. We try to forecast where our submarkets will be in terms of rental rates and ensure that we can cover our costs and still compete with other new and relatively new properties nearby when those higher costs are factored in.”
Which is about as tricky as it sounds, but developers are more than happy to take that chance because rent growth is still holding its opposing forces at bay.
According to the latest data from CBRE, the average rent in Dallas-Fort Worth increased by 4 percent from $1.51 to $1.57 per square foot between the third and fourth quarters of 2021. On a year-over-year basis, rent growth throughout the metroplex rose by 15.3 percent in 2021, in part because new deliveries tapered off in the second half of the year.
A similar situation exists in Austin, where high-paying jobs are arriving in droves. CBRE’s data shows that the marketwide occupancy rate was 97.1 percent at the end of 2021. In addition, the average asking rent at the end of last year was $1,563 per month, up from $1,252 per month year over year. However, the report notes that rent growth between the fourth quarter of 2020 and the first quarter of 2021 was essentially flat, meaning that average rents increased by nearly 24 percent during the last three quarters of last year.
“The best thing we can do is listen to all the information we have at hand and try to make a calculated forecast while making sure we are protecting the downside risk for all of our partners,” notes Lerner of Allied Orion Group. “With real estate, it’s always about location, location, location. Find the right location that makes sense from a conservative pro forma approach, and you will be successful.”
That mentality may be old-school, but it’s certainly not outdated, particularly when it comes to Class A high-rise projects in dense urban markets, according to Yewande Fapohunda, senior vice president at High Street Residential.
“With more dense and urban product like high-rises, everything takes longer, and the business plan can be more challenging,” she says. “The design process alone can take years. Because of the high bar for these projects — regardless of what market you’re in — success usually rests on the outstanding qualities of the site. These projects go back to the fundamentals of real estate; it’s the location that survives the economic ups and downs.”
High Street Residential, which is the multifamily development arm of Dallas-based Trammell Crow Co., recently topped out Parkside Residences at Discovery Green, a 43-story high-rise project in downtown Houston. Construction of the 309-unit community began in July 2020, and the first move-ins are scheduled to commence this summer.
Fapohunda also points out that even during inflationary periods, these projects have the attributes that can better attract renters who are less affected by price escalation.
As such, High Street Residential focuses on offering a combination of top-notch interior finishes, a comprehensive communal amenity package, vibrant neighborhood surroundings, and an excellent management team that provides stellar service to residents. In these ways, the company shields its developments from broader economic headwinds. This includes a global pandemic that theoretically impacts almost all consumers and businesses on some adverse level.
“You may look up and see inflation up in the near term, but job growth is returning to pre-pandemic levels, and the savings rates of many upper-income renters and homeowners actually increased over the past two years,” she continues. “In Houston, we are encouraged by expansion in certain industries, especially healthcare and energy, which generate great-quality jobs and support their employees’ economic mobility and Class A housing choices.”
— This article originally appeared in the March 2022 issue of Texas Real Estate Business magazine.