Weak Oil Price Outlook Puts Houston Multifamily Sector Back on Its Heels
Houston is less reliant on the oil and gas industry than it once was, and considerable strides have been made to diversify the economy away from the oil patch. Still, the hard reality remains: Houston’s prosperity and hydrocarbons are intrinsically linked. Decoupling one from the other will be devilishly difficult.
The world will derive the preponderance of its energy from oil and gas for decades to come, but market share will continue to diminish, and oil and gas revenue inevitably will stagnate and decline. Developing alternative economic drivers will be challenging, but Houston has the benefit of time on its side.
However, the current coronavirus crisis is negatively impacting oil prices and therefore the Houston economy in the near term. Following the shutdown of the global economy to fight COVID-19, the price of a barrel of crude plunged from over $60 — well above the marginal replacement cost from East Texas fields — to less than $20. Although prices recovered to the mid-$30 range recently, they remain below the marginal cost of discovering and extracting a replacement barrel, annulling the incentive to prospect for new reserves or build additional refining and transportation capacity.
Indeed, the Houston economy was impacted more severely than other large Texas metros during the first weeks of lockdown. The number of employed residents plunged by more than 600,000 between February and April, sending the unemployment rate soaring from 3.9 percent to 14.2 percent, the highest level recorded among Texas metros with labor forces greater than 1 million.
Is the Bayou City’s underperformance attributable to exposure to the energy industry? Perhaps in part, but available data suggest that this connection may be exaggerated. Had energy dependence been Houston’s Achilles’ heel, one would expect Midland — a famously energy-centric economy — to still be in greater distress. In fact, although recent job losses were substantial, Midland reported among the lowest of the April rates of unemployment in Texas (10.2 percent).
Still, don’t be too quick to write off Houston’s multifamily market. The team at RED Research remains optimistic that the Houston economy will recover with considerable strength regardless of the fact that oil prices are likely to linger below pre-COVID-19 levels for several years.
Our forecasting equations for metro personal income and payroll job growth each include the annual change of West Texas intermediate crude price as a statistically significant predictive variable. But in both models, the related coefficient is small in size and the impact of price changes on the forecasted variable commensurately modest. Based on 30 years of government data, U.S. nominal GDP, personal consumption and money supply growth are far more closely correlated to Houston prosperity than the price of oil.
As outlined by Fed Chairman Powell in early June, the elements for a strong recovery are in place, with GDP growth of 5 percent and 3.5 percent anticipated for 2021 and 2022. Our models generate a similar forecast. Under this scenario, Houston payrolls are expected to recover to pre-coronavirus levels by mid-year 2022, followed by annual job creation totals exceeding 80,000 in each of the following two years. Economic diversification can wait.
The implications for the multifamily performance are mixed. As in Dallas, Houston has an ample construction pipeline to digest. Currently, about 20,000 units are under construction in the metro area, and 12,000 or more will be completed between April and December. Our demand model projects that net absorption is likely to be positive for the same period but fall far short of supply — somewhere in a range of 3,000 to 8,000 units — contributing to a 70 to 150 basis point decrease in market occupancy to the high 92-percent to mid-93 percent range. Although market performance will improve next year, moderate occupancy declines again are likely before equilibrium is reestablished in 2022.
Rents also are likely to fall. Our rent model employs payroll employment, lagged nominal GDP and occupancy as independent variables. Each will weigh on rent trends. Consequently, effective rent is expected to decrease about 2 percent this year, losses that are unlikely to be recovered before summer 2021.
Investors will be rewarded for patience, however; Houston’s recovery will lag the nation by a quarter or two, but it will pack a punch when it arrives. With plenty of economic slack to redeploy, income and employment are poised to rise at the fastest rates since 1997, propelling rents higher by 6 percent or more as they did before in 1999 and 2018. Investment returns may not match those available in Austin and Dallas, but buyers should not hesitate to seize upon opportunities while this metro is temporarily caught on its back foot.
— 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.