Recession Pays an Unwelcome Visit to Dallas Multifamily Sector
Some places in America are painfully accustomed to economic setbacks. Dallas isn’t among them. This growth market prototype has elevated expansion to an art form and won’t suffer recession gladly.
But happily or not, Dallas must share with the rest of the nation the unanticipated discomfort of our pandemic disaster. How is it likely to respond, and what are the ramifications for multifamily investors?
It is said that everything is bigger in Texas, and Dallas job losses in the first months of the COVID-19 lockdown definitely were “on brand.” Payroll employment declined nearly 300,000 jobs in March and April, and the unemployment rate, which never before surpassed 9 percent, soared to 12.8 percent in April.
The night is darkest before the dawn, however, and the latest national job numbers suggest the sun is near the eastern horizon. If recent history is any guide Dallas will be one of the first to recover and among the quickest to return to pre-coronavirus strength. Indeed, the metro labor market recovered about six months before the nation following both the 1992 and 2009 recessions, and job growth returned to pre-recession levels about 12 months later, a process that took the nation nearly two years during those previous recoveries.
What is it about this metro area that makes it stand out in this way? Its statistical relationship to the U.S. output gap is one. The output gap is a measure of slack in the economy, expressed as the difference between the actual output of an economy and its theoretical potential. Analysis of payroll data from 1980 to 2019 demonstrates that the output gap is more closely correlated with employment growth in Dallas than any other major metropolitan area, suggesting that this metro is singularly adept at redeploying idle human and physical capital when the U.S. economy recovers after a recession. Only Austin and Atlanta are in the same league.
Dallas seems to have a knack for “creative destruction,” the name economist Joseph Schumpeter gave to the process of invention, technical innovation and efficiency that drives economic growth in a free market economy — it pieces together the broken parts of an economy with less friction than its growth market rivals. The pool of skilled workers is deep and quickly redeployed as the needs of the market shift. Office, industrial and warehouse space is varied, readily available and quickly scalable when demand calls for it. Local governments are comfortable with rapid population growth and the attendant construction of new housing and social infrastructure.
This protean nature of Dallas’s labor force and business leadership will serve it well as growth returns. Quantifying the recovery is difficult given the uncertain course of this viral infection. We are optimistic that economic lockdowns will pass quickly as the summer heat returns and that any “second wave” of infections will be local events without broad economic consequences. In our base forecast, we anticipate that U.S. GDP will increase about 3 percent in 2021, and 5 percent in 2022, catalyzing net creation of about 100,000 jobs in the Dallas-Plano-Irving metropolitan division next year and as many as twice that number in 2022. Payrolls should return to pre-COVID-19 levels by spring 2021.
Unfortunately, Dallas multifamily investors aren’t out of the woods yet. The RED Research team expects 2020 job losses to exceed 100,000. Enhanced unemployment benefits notwithstanding, net absorption is likely to be deeply negative, with net move-outs totaling 10,000 units, perhaps more, from April to September, according to our historically specified models. At the same time, supply will be substantial. Currently, approximately 45,000 units are under construction, and about 12,000 to 15,000 units are likely to be delivered between April and December.
Consequently, metro occupancy rates will decline materially, perhaps testing the 90 percent level before year end, using the Reis baseline, from about 94 percent in March. Rents will come under a degree of pressure as well. Our model projects that rents may fall as much as 3 percent in 2020, not considering the mitigating impact of enhanced unemployment benefits.
Investment returns will suffer accordingly. After enjoying average annual unlevered returns of about 14 percent over the course of the last five years, total returns may be deeply negative this year. Property values could plunge 10 percent or more unless cap rates on current income decrease commensurately.
The intermediate return outlook, by contrast, remains favorable. The powerful recovery envisioned by our models and diluted supply pressures will permit occupancy and rents to recoup ground lost this year by winter 2022. As a result, even investors who purchased properties in the winter quarter before the coronavirus disruption should enjoy attractive annual returns over a five-year hold, by our estimate in the mid-8 percent area. High risk-adjusted returns are an added bonus, as the metro falls in the first decile of our large market peer group on this count. Dallas no longer is an undifferentiated commodity market and asset returns will continue to highlight this fact, even in today’s uncertain market environment.
— By Daniel J. Hogan, ORIX Real Estate Capital’s Managing Director for Research. RED Mortgage Capital, a division of ORIX Real Estate Capital LLC, is a content partner of REBusinessOnline. The views expressed herein are those of the author and do not necessarily reflect the views for RED Capital Group or of the author’s colleagues at RED. For further analysis from RED Capital Group, click here.