Multifamily Developers in Houston Focus on Affordability
With a historic drop in oil prices amid a global pandemic, fate dealt Houston a bad hand in 2020, to put it mildly. But this is not the first time the city has seen bleak conditions — and faced them down.
In 2015-2016, the metropolitan area was throttled by a double whammy of an oil bust and the Memorial Day and Tax Day floods, decimating a full 10 percent of its multifamily housing stock. Yet, by 2020, the city’s job growth exceeded the national rate for the 25th consecutive month, and its multifamily market was set to deliver nearly 17,000 units, double the volume from 2019.
Before the oil crash and COVID-19 pandemic hit, Houston’s increasingly diverse economy meant that its fundamentals were strong, and demand was growing for multifamily. Through hurricanes, floods, tornados, boom-and-bust cycles in the oil and gas markets and more, Houston persevered.
Houston has one of largest metropolitan populations in the U.S. and is growing, adding more than a million people since 2010. This 2-percent-per-year average growth is more than twice the 0.7 percent average for the United States. Of the 10 largest metropolitan areas, only Dallas-Fort Worth and Houston have been able to grow at this pace. Furthermore, Houston is home to an international port, which generates $801.9 billion in economic value each year, and Texas Medical Center, the eighth largest business district in the United States and employer of over 100,000 people.
Finally, the city’s unique lack of zoning — which leads to cycles of overdevelopment and demands in-depth local knowledge — has a powerful positive side, particularly when coupled with abundant, comparably affordable land.
There are no oceans or mountains. Just wide-open prairie: no barriers to entry physical or otherwise. Apartments can pop up anywhere.
All of these qualities make Houston a market to watch in 2020 and beyond.
The Current Landscape
Just as certain sectors, like industrial and grocery-anchored retail, have continued to see financing through the crisis, multifamily has remained liquid in Houston, with a few caveats and considerations.
If you’re in the Houston market already, “Revise your holding period and horizon and focus on staying cashflow positive until it’s more profitable to divest,” says Mike Melody, managing director, Walker & Dunlop. “Owners won’t get top dollar for properties now.”
Furthermore, new construction may not be cost feasible for several months, particularly in certain sectors.
“Capital isn’t totally shut off from new development, but a new development deal needs to have a unique positioning relative to other alternatives — irreplaceable basis, advantageous transaction structure or unique resident value proposition to attract attention,” says Jonathan Paine, managing director, Walker & Dunlop.
One reason for this calculus is Houston’s position in the development cycle. Houston saw more than 80,000 units delivered between 2014 and 2018 and 24,872 multifamily units under construction in the first quarter of 2020 in many of the city’s hottest new markets (including Montrose Heights and Medical Center west of downtown). Much of this overbuilding involves Class A properties. Think luxury high rises with sky lounges and bespoke floor plans in Houston’s Inner Loop.
Today, operators of luxury and Class A high rises are giving away significant concessions. Class A properties, which face the most competition from new developments, have seen the most prominent rent declines, with effective rents falling by 0.7 percent year to date. Meanwhile, Class B, B- and C properties are over 90 percent occupied, and rents in Class B properties are up by 0.9 percent year-to-date.
Immediate Opportunities in Value-Add
As in cities across the United States, workforce and affordable housing have become a growing need in Houston. According to Mark Thiele, interim president and CEO of the Houston Housing Authority, one in two Houston renter households — over 430,000 total households — pays more than 30 percent of their income in housing.
There’s a huge opportunity for new apartment projects that don’t need $2,000-a-month rents to make money. If one can give a tenant a nice product at an affordable rate, there’s a need for that.
Thanks to federal aid after Hurricane Harvey and Mayor Sylvester Turner’s commitment to affordable housing, ample programs exist for affordable and workforce housing. Opportunity also exists in Class C value-add projects — where investors can find an older property and fix it up, particularly in an emerging neighborhood.
Where to look? Close to downtown, Eastern Downtown (EaDo for short), remains an emerging leader with its proximity to METRORail, restaurants, shopping, nightlife and the new Houston Astros stadium, as well as both Texas Medical Center and the port.
“There’s still a significant price difference between east and west of downtown, and we think that will continue,” says Mike Melody.
Houston’s suburbs — like Katy, Spring (home to ExxonMobil’s Houston campus) and Tomball — offer developers affordable land and offer residents less congestion, lower rents and larger garden-style apartments, which may be particularly appealing after COVID-19 stay-at-home orders. Katy, in particular, is a place to watch, with 4,200 units underway and 13 developments under construction as of mid-2019.
Other submarkets to watch include the master-planned community of Woodlands to the north, as well as semirural areas east between Houston and Beaumont and south en route to Galveston. With Houston’s no zoning laws, it’s important to enlist local expertise.
“You can build anywhere but some areas are more difficult. It’s particularly important here to have advisors in this market,” says Tom Melody.
For Long-Term Investments, Follow the Jobs
Global businesses are moving operations to Houston. Katy, for example, has the 1,000-employee headquarters of Saudi Arabia-based oil company SABIC under development. In downtown Houston, military construction contractor MVL Group purchased the historic Republic Building and is renovating the 113-year-old Paul Building as its new corporate headquarters. Meanwhile, the southwest suburbs of Rosenberg, Richmond will soon be home to an 850,000-square-foot Amazon fulfillment center and Brazos Town Center, one of the largest retail projects in Texas.
Concurrently, the medical and energy cornerstones of the city’s economy are driving innovation. Texas Medical Center is building a new a multibillion-dollar bioresearch campus, for example. While oil and gas maintain their importance to Texas’ economy, 95 percent of the capacity now entering the Texas electricity grid comes from solar, wind or storage.
“Over the past two decades Houston has added the equivalent of the population of Austin to its ranks, and consistently employs more people each year,” says Tom Melody. “It’s a very business-friendly climate with a comparatively affordable cost of living. If we can maintain reasonable job growth in the next few years, we’ll absorb the current oversupply and return to a rebalanced market.”
The year’s statistics look promising. Cap rates have held steady at near 5.8 percent on average in the first half of 2020. Effective apartment rents average $1.22 per square foot, falling between Charlotte and Milwaukee in terms of affordability. And while the market average vacancy rate of 10.3 percent is up year to date, vacancy of stabilized properties is 9 percent, similar to the rate at the beginning of the year.
Download Walker & Dunlop’s full Multifamily Outlook here.