FEATURE ARTICLE, AUGUST 2006

STEPPING OUT OF THE HOUSING SHADOW
With the housing market starting to cool off, multifamily properties are re-emerging as an attractive asset for investors.
Lara Fuller

The multifamily market is beginning to regain some of the ground it had lost due to the for-sale housing boom of the past several years. Multifamily lending activity has increased in Texas — in both major cities and more mid-sized ones. In many areas, rental vacancies are decreasing and there is a growing demand for multifamily properties. Texas Real Estate Business recently spoke with three Texas lending firms to get their take on the multifamily market at the moment.

The Current Climate

The Texas multifamily market is improving across the state, due to a number of factors. The increase in interest rates and the slowing of the for-sale housing market has had an effect, as has Hurricane Katrina. Whatever the reason, multifamily properties are looking like an attractive investment to borrowers.

“The current lending climate in Texas is very competitive,” says Larry Zieman, senior vice president with Citigroup in Dallas. “A generally optimistic economic outlook coupled with an aggressive capital markets environment has attracted lenders throughout the nation into the Texas market.”

“We continue to be in a very competitive environment for multifamily lending,” say Jimmy Mayfield, managing director, and Tony Spaeth, national accounts manager with Greystone Servicing Corporation. “Lenders are taking on increasingly more risk, lending more dollars based on skinnier debt service coverage than has been common in the past.”

“It’s a good day to be a landlord –—or a landlord’s lender for that matter,” says Tim Young, senior vice president with KeyBank Real Estate Capital. “’For Rent’ signs are becoming less common throughout Texas. As the market for home ownership cools, people still need a place to live. In fact, in the last 18 months, the lending climate for multifamily properties has improved considerably, with much credit to be given to the slowing of the for-sale condominium and single-family home markets.”  

Most-Wanted Markets

For the most part, multifamily lenders are doing well at the moment,  as many cities have seen a positive turnaround in the multifamily market. “There is not a major market in Texas that we consider to be a struggling market right now,” say Mayfield and Spaeth.

And markets that did have trouble in the past are beginning to bounce back. The Austin market, for example, suffered in the past but is now starting to turn around. “Austin is coming back from the overbuilding around the tech bust,” say Mayfield and Spaeth.

Adds Young, “Austin is doing very well and is considered the best apartment market in Texas. It has had rent growth and most submarkets are reporting very strong occupancies and mid- to high nineties overall occupancy rate.”

Other Texas cities that are continuing to strengthen include San Antonio and El Paso. “The most active areas of the Texas region are currently Austin, San Antonio and El Paso,” says Zieman. 

Mayfield and Spaeth agree. “San Antonio and El Paso remain as traditional, steady performers and are maturing as deeper markets on the radar screens of many institutional investors,” they add.

Houston, however, has a different story from the rest of Texas. The aftermath of Hurricane Katrina affected the city in multiple ways. Because of the great influx of Katrina evacuees, there has been a great demand for housing, but other issues have also arisen.

“The Houston area is struggling with rising insurance costs and the uncertainty related to the collections and continued occupancy of Katrina tenants in a large number of Class C properties,” says Zieman. “This issue is somewhat mitigated by the strong economic indicators for job and population growth in the Houston area, particularly in the energy sector.” 

“Houston continues to ride the wave of Katrina evacuees and higher energy prices,” say Mayfield and Spaeth. “We see a lot of deals in Houston, both for refinance and acquisition, as deals that would not have happened prior to the glut of Katrina evacuees but are now considered viable. There now appears to be a general acceptance that a significant portion of the evacuees will be staying.”

Popular Products

As the multifamily lending climate is changing in Texas, so are the lending products. Investors are looking to lenders for new ways to finance properties. “In the past, certain borrowers have traditionally leaned toward agency debt through Fannie Mae DUS lenders or Freddie Mac seller/servicers because of the ability to apply for additional leverage during the loan term,” say Mayfield and Spaeth. “Now, many of these borrowers are entertaining aggressively-sized conduit quotes, with the logic that ‘I’m getting my supplemental loan today.’”

Greystone has also seen a continued popularity of bridge loans for deals that are in transition or aren’t ready for permanent loans. “Borrowers have been very responsive to our ability to couple a bridge loan with an early rate lock for one of our permanent financing programs,” say Mayfield and Spaeth.

Acquisition/bridge financing is also a popular loan product at KeyBank. “Growth in Texas has been steady with no real over-building,” says Young. “In fact, the major concern in this sector continues to be the rising cost of construction materials. This alone will probably keep markets from getting overbuilt. Related to this, KeyBank Real Estate Capital has seen much of its lending activity in the acquisition/bridge financing sector. Construction lending is less prevalent because of rising costs.”   

At Citigroup, the most popular lending pro-ducts are generally long-term (5-year, 7-year and 10-year) and fixed-rate loans on 30-year amortizations, or coupled with 1 year to 2 years of interest only. “Lately, more and more lenders are lending at higher LTV’s, frequently incorporating mezzanine financing,” says Zieman.

Future Forecast

As the multifamily market is just now beginning to gain strength and move forward, most lenders see the trend continuing for a while. “Loan demand is anticipated to remain strong for the next couple of years in the multifamily sector,” says Young. “With building costs and properties trading at historically low cap rates, experienced developers and owners with strong construction management and property management teams are expected to be the driving force in the market. The less experienced and undercapitalized owner/ developer is probably going to get squeezed out, due to the risks associated with working with an inexperienced team. In addition to market-driven apartments, niche opportunities such as age-restricted and student housing projects are also anticipated in the upcoming months and years.”

Another reason multifamily will remain on the upswing is due to the arrival of buyers from the West Coast. “Texas has experienced a large influx of West Coast buyers, primarily from California, over the past couple of years,” says Young.

“Texas in general remains an attractive alternative for investors to move their money when cashing out of higher-priced markets like the West Coast,” add Mayfield and Spaeth.

“These buyers are primarily utilizing 1031 exchange funds to purchase properties with more attractive cap rates and lower per-unit costs,” says Zieman. “As long as the California market remains strong and active, this trend is expected to continue. The downside to this phenomenon is that prices for commercial property in Texas have been driven up by this activity.  The 1031 buyers will pay slightly more for a property because of their tax incentive, and secondly, many buyers are willing to take a lower return because they are comparing the returns to what they could achieve on the West coast.

As buyers both in- and out-of-state continue to invest in Texas properties, the lending market will thrive. Interest rates are expected to continue to rise, though not dramatically over the next year. Either way, multifamily investments will remain popular. “Multifamily product continues to be the most sought after investment real estate product in Texas, both by lenders and equity investors,” say Mayfield and Spaeth.

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