Spotlight on Houston

Focus on Houston

A historic drop in oil prices, a global pandemic—fate dealt Houston a very difficult hand in 2020, to put it mildly. But this is not the first time the city has faced 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.

Opportunity abounds for investors with ready cash and an appetite for risk

Right before the oil crash and COVID-19 pandemic hit, GlobeSt. wrote that “Houston’s ever-diversifying economic engine continues to hum along, precipitating the need for more multifamily housing,” adding that “the Houston multifamily market is bolstered by strong metro area fundamentals, with a broadened economic base going into 2020 and beyond that will continue to drive demand for the sector.”

Through hurricanes, floods, tornados, and boom-bust cycles in the oil and gas markets, and more, Houston has persevered. It has one of largest metropolitan populations in the U.S. and is growing, adding more than a million people since 2010. This 2%-per-year average growth is more than twice the 0.7% average for the United States. Of the ten 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 that 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 physically or otherwise. Apartments can pop up anywhere,” said Tom Fish.

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 cash-flow positive until it’s more profitable to divest,” said Mike Melody. “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,” said Jonathan Paine.

One reason why is where Houston is 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, many in the city’s hottest new markets, like 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% year-to-date. Meanwhile, Class B, B- and C properties are over 90 percent occupied, and rents in Class B properties were up by 0.9% 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, pays more than 30% 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,” said Tom Fish. “If you 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—finding an older property and fixing 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, the new Houston Astros stadium, and both Texas Medical Center and the port.

“The ‘no barriers to entry’ aspect of Houston may be our greatest weakness in terms of allowing new supply, but it is also our greatest strength. It is this same lack of barriers that create real economic opportunity and long term sustained population growth and diversity that makes Houston such a resilient and special city.” - Tom Fish // Managing Director

“There’s still a significant price difference between east and west of downtown, and we think that will continue,” said Mike Melody.

Houston’s suburbs—like Katy, Spring (home to ExxonMobil’s Houston campus), and Tomball in Harris County—these areas offer developers affordable land and 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 in mid-2019.

Other submarkets to watch include the master planned community of Woodlands to the north, as well as semi-rural 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,” said Tom Melody.

Follow the jobs for long-term investments

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 multi-billion-dollar bioresearch campus, for example. In oil and gas, 95 percent of the capacity now entering the Texas electricity grid comes from solar, wind, or storage.

“Houston over the past two decades has added the equivalent of the population of Austin, and consistently employs more people each year,” said 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% 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% is up year-to-date, vacancy of stabilized properties is 9%, similar to the rate at the beginning of the year.

Read the full Multifamily Outlook!