Austin remains a destination for institutional and private investors

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Austin remains a popular destination for institutional and private multifamily investors. In the first half of 2010, there was a scarcity premium as buyer demand far exceeded the number of properties offered for sale. It was common to give 50-plus property tours and receive roughly 40 offers for a fully marketed Class A apartment community. The enormous amount of investment capital raised in 2008 and 2009 struggled to find a home in early 2010. As apartment fundamentals improved, interest rates decreased and cap rates compressed, more product came to market in the third quarter of 2010. Subsequently, the number of investor tours and offers has been cut in half. Offers today are coming from well-capitalized low leverage private investors, pension fund advisors, private funds and public REITs.

Urban Class A cap rates have dropped from 6.5 percent in late 2009 to an average of 4.75 percent today. Suburban Class A cap rates are trading around 5.25 percent. The 1980s to 1990s vintage, B class product, is trading in a range from 5.75 to 6.75 percent based on quality and location. The highest conventional apartment sales prices have occurred in and around the Central Business District (CBD) where mid-rise Class A product is trading in the $150,000 to $180,000 per unit range. Suburban Class A garden-style product is trading in the $75,000 to $85,000 per unit range. Class B product has traded in the $40,000 to $50,000 range, while Class C apartments have averaged $15,000 to $35,000 per unit, heavily dependent upon product condition.

The year one cap rate is no longer the metric of choice for Austin’s multifamily investors. Buyers appear to be paying an aggressive year-one cap rate, but the common belief is that this cap rate is based on short-term depressed market fundamentals. Austin apartment communities are recovering from apartment over-supply that created up to 3 months of rental concession. The supply pipeline has been turned off just as the economy appears to be gaining steam and concession is on the decline. The popular belief is that Austin’s economic recovery will generate 5 to 7 percent annual rent growth for the next 5 years. Investors are using the 5-year Internal Rate of Return (IRR) projection as opposed to the year-one cap rate to evaluate an asset’s investment potential. Recent trades in Austin have illustrated that investors are modeling to a leveraged 13 to 15 percent IRR.

Austin is coming off 2 years of heavy apartment construction and heading into a period of near zero supply. Roughly 7,500 units per year were built in 2008 and 2009, and today, there is zero in the conventional apartment pipeline. Recovering apartment fundamentals and the scarcity of bank financing should keep supply in check for the foreseeable future. Due to Austin’s rapid growth and congested traffic, it is not possible to make blanket assumptions about how supply will affect the entire MSA. It is important to dissect the city by submarket to note the effect supply will have on a particular area. In 2008, the top submarkets for supply were Round Rock, Far North, South Austin, and the CBD. Currently these submarkets are in recovery mode, experiencing 90 percent-plus occupancy and concession burn-off. The suburban submarkets are undergoing a slow steady recovery, while the CBD is popping. The CBD submarket has experienced a 10.3 percent increase in quarterly rent growth and a 15 percent annual growth rate. The sharp turn in rental rates is the result of supply going to zero and demand from urban professionals that want to live, work and play in the CBD environment.

Downtown Austin has undergone a dramatic transformation in the past 5 years and continues to transform into an urban living oasis. Towering high-rise residential buildings have sprung up across the city and are now dominating the skyline. The city of Austin has encouraged the development of high-density mixed use residential projects with ground floor retail in an effort to create a new, pedestrian friendly, urban core. The goal of city government is to have 25,000 people living in downtown by 2015 (currently 9,500 people reside in the CBD). Developers embraced the initiative and since 2007, downtown Austin has seen the construction of roughly 2,300 apartment units and 1,177 condominium units.

The first wave of downtown condominium development included Milago, The Shore, and 360. These projects had the benefit of being marketed prior to the recession and successfully sold out. Downtown condominiums are attracting young professionals, empty nesters, and University of Texas alumni, all wanting the convenience of an urban environment surrounded by a vibrant music and cultural scene.

— Patton Jones is managing principal of the Austin office of ARA.

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