HOUSTON — After several years of sluggish rent growth, heavy concessions and tepid absorption brought on by the oil slump, investors are returning to Houston’s multifamily market with quite a bang.
Rent growth and absorption were particularly weak in the city’s Class A multifamily space over the past few years. But with oil prices stabilizing (currently at about $68 per barrel of West Texas intermediate crude) and overall population growth still booming, multifamily investors are rethinking their positions on the Bayou City.
“For the past two or three years, capital had been going elsewhere,” said Bruce McClenny, president of Houston-based research firm Apartment Data Services, during his keynote address at the second annual InterFace Houston Multifamily conference. “But that’s about to change.”
Panelists at the event agreed that Houston’s construction pipeline for new apartments is thinning, stabilized properties are being brought to market and sellers are seeing more bids on assets they’re marketing. All this activity points to a previously overbuilt market turning the corner.
Multifamily developers, lenders and brokers discussed these trends and others at the conference, held on Tuesday, April 17 at the Royal Sonesta Hotel in Houston’s Galleria neighborhood. The event drew about 150 real estate professionals.
A Capital-Rich Market
A hefty amount of capital in the national multifamily investment market is among the more impactful drivers of heightened demand for Houston’s multifamily inventory. Approximately $33 billion in private equity funds for multifamily investment was raised during the first quarter of 2018, according to data from Berkadia.
The abundance of capital has been available throughout the oil slump, which began in late 2014 and bottomed out in early 2016. But multifamily investors largely steered clear of Houston during that stretch.
McClenny pointed to the displacement of single-family residents by Hurricane Harvey, which struck the Houston area in August 2017, as the chief driver of the multifamily market’s turnaround. He noted that the sector closed 2017 with positive rent growth of 4.4 percent and positive net absorption of approximately 18,000 units.
By comparison, Houston posted -0.1 percent rent growth and net absorption of about 4,600 units in 2016, according to data from Apartment Data Services.
Overall occupancy ended the year at 89.7 percent, up from 88.4 percent at the end of 2016.
Houston’s multifamily fundamentals improved dramatically toward the end of 2017 following Hurricane Harvey.
This reversal of market fundamentals, combined with the 63,000 new jobs that the city added in 2017, has private and institutional investors alike convinced that Houston is once again deserving of their dollars.
“Most brokers agree that from the standpoint of selling Houston, our jobs have gotten a lot easier,” said panelist Zach Springer, executive managing director at ARA Newmark. “During the oil slump, it was a real struggle to sell Houston. But now, buyers as a whole are opportunistic and it’s becoming one of the more aggressive markets for investment that we’ve seen.”
Springer added that on deals for Class A properties in Houston, his firm is routinely fielding anywhere from 25 to 30 offers. Competition is also strong for Class B and C assets, which typically draw between 15 and 20 offers.
A good example of these trends in action involves Grand Mason at Waterside Estates, a 229-unit, Class A community located in the southwestern Houston suburb of Richmond. The property, which sold in February, was on the market for less than a month, during which time it received more than 20 offers. Four of the prospective buyers were prepared to put down hard money on the first day.
Panelist Chris Curry, managing director at HFF, commented on how quickly multifamily investors have changed their tunes on Houston.
“Our office’s total transaction volume for investment sales increased by more than 100 percent during the first quarter of 2018 versus the first quarter of 2017,” said Curry. “The average deal size is up more than 20 percent, which speaks to stronger demand for Class A product, as well as to how the Class B and C spaces really carried Houston over the past couple years.”
Declining Volume of Construction
A more balanced supply-demand equation is also contributing to renewed investor interest in Houston’s multifamily sector. After delivering nearly 20,000 new units in each 2016 and 2017, the market is expected to add approximately 6,400 new units in 2018. That figure should be even lower in 2019, according to McClenny.
“Harvey pushed us into a totally different development cycle,” he said. “We expect 2019 to be a year of minimal deliveries, maybe 4,000 or 5,000 at the most.”
Panelist Greg Austin, managing director at JLL, noted that Houston, which has added about 125,000 residents per year over the last decade, could see its 2018 absorption rate drop from peak levels of late 2017. But even if that did happen, the decline in new construction should still be significant enough to foster rent growth and keep investors interested, he said.
“With oil back at a more sustainable price range, we’re going to have more jobs coming to Houston,” said Austin. “When you pair that with the slowdown in new construction, you’re going to see the stabilizing of the occupancy rate, the lessening of concessions and locator fees, and anything else that causes the numbers to flatten out for the operators.”
Lenders Respond to Demand
As dwindling supply and steady oil prices boost demand for multifamily assets and draw investors into the space, the market for debt and equity on multifamily deals in Houston is also heating up.
Construction costs are rising and it took a natural disaster to absorb much of Houston’s vacant units and get rent growth back on track. It therefore comes as little surprise that cap rates on stabilized multifamily properties are compressing, with the exception of merchant-built assets in suburban submarkets that lack value-add opportunities.
“The cap rate compression has created an incredibly competitive debt market,” said panelist Catherine Justice, production manager at Freddie Mac. “Whereas we used to leverage deals in Houston at 80 percent, now we’re lucky if we can do them at 75 percent. We’re also seeing a lot more competition to provide debt and equity from debt funds and life [insurance] companies.”
The variety of competitors making plays in Houston’s multifamily market also extends to the borrower side, according to panelist Corby Chaffin, senior director at Berkadia.
“It’s a pretty diverse buyer pool,” said Chaffin. “You’ve got institutional capital competing with private capital and both sides competing against foreign capital. In a lot of cases, the winning bid has gone to parties that have traditionally been outliers of the pack.”
Lenders in Houston’s multifamily space are encouraging investor competition and demonstrating a willingness to grant favorable terms to sponsors with less-established credit and track records as operators. With capital so readily available, developers and operators in Houston are beginning to cross the line and function as investors, the panel concurred.
“These operators who are becoming buyers, they see the discount-to-replacement cost in buying compared to building,” said JLL’s Austin. “And remember, for the last 18 months, their capital sources haven’t been willing to lend for new projects in Houston. But these investors have to keep deals going, so we’re seeing them buy and operate as if they built the properties themselves.”
— Taylor Williams