COVER STORY, JANUARY 2009

THE SILVER LINING OF MULTIFAMILY
Texas continues to avoid the worst of the housing downturn.
By Coleman Wood

While the economic situation in other parts of the country continues to deteriorate, a rallying cry of “Be thankful we’re in Texas” can be heard from real estate professionals located across the Lone Star State, especially those in the multifamily sector. The current recession hasn’t hit this state or this sector as hard as other parts of the country, and Texas’ brokers, developers and builders are doing their best to make sure the damage is minimal. Still, 2009 brings with it a lot of uncertainty. So Texas Real Estate Business tracked down the brokers and researchers who know the Texas multifamily sector best, and asked them what they think the New Year will hold.

“We have had a slowdown of the economy, but nowhere near what we’ve seen in other parts of the country,” says Greg Willett, vice president of research for M/PF Yieldstar, a Carrollton, Texas-based company that provides market analysis for the multifamily sector. He adds that the market has weakened slightly statewide, but far less than the nation as a whole.

The reason for this is that the housing bubble never quite happened in Texas. Single-family construction was based more on need than speculation, and the state’s major cities did not have the glut of new condo construction seen in other metropolises. Because of this, when the housing bubble burst in late 2007, Texas simply had less housing secured by bad loans.

“We’re not struggling with foreclosures to the degree seen elsewhere,” Willett says. “Beyond the basic industries that are still doing okay in Texas, I think it really comes down to the fact that we didn’t mess up on the single-family side of the equation.”

To Scott Weems, associate partner at the San Antonio office of Hendricks & Partners, 2008 started off pretty good, but had unraveled completely by late summer due to the credit freeze. Activity has declined dramatically since, leaving many to play catch-up with the current market.

“The biggest trend of [2008] was that people really began to realize that the market has changed, and that was a big sea change that started around September. An awful lot of people were way behind the curve on that,” Weems says.

Weems adds that in his city well-operated properties are doing well right now, but some properties that are not as well-operated or financed, much like in other parts of the country, are starting to suffer.

“I think that our market will hold up relatively well, compared to other parts of the country,” Weems says. He adds that next year will be flat, as compared to the downward trend many cities are experiencing. The San Antonio multifamily market will not see significant income increases and expenses will start to creep up, making it difficult to increase net operating incomes.

A bright note, though, is that construction is ramping up at Fort Sam Houston, where $2 billion in new construction is under way at Brooke Army Medical Center. Plans are to make Brooke Army the center for military medical services for the United States, adding 12,000 medical jobs to the city and, therefore, increasing demand for housing significantly. Despite the current setback, San Antonio is emerging as a major market in Texas and the rest of the country.

Along with San Antonio, Dallas/Fort Worth is expected to fare best out of Texas’ major markets in 2009. According to Tom Warren, a partner with Hendricks & Partners’ Dallas office, both metropolitan areas will see average occupancies of 90 to 93 percent; San Antonio will see average rent growth of 2 percent, while Dallas/Fort Worth will see rent growth of 2 to 3 percent. Additionally, DFW will post one of the best job growth numbers in the country, by adding 50,000 to 60,000 new jobs this year. It expects to equal that number next year.

“As long as you have jobs and you have job growth, your apartment business is going to do well,” Warren says.

The general consensus is that Houston is expected to remain flat in 2009. However, Jim Hearn, a partner at Hendricks & Partners’ Houston office, believes that Houston will be able to hold its own. Transaction activity has been down, but property performance remains good compared to the national market. He sees the slowdown in activity of the coming year as somewhat of a good thing.

“With lending at a near standstill, the top end of the Houston market will have a chance to finish off its large pipeline of new deals, giving the city a chance to rise above the overall low occupancy that it has had for several years,” Hearn says.

At the other end of the scale is Austin, which is expected to move backward in the coming year. Occupancies are expected to come in at 90 to 91 percent, but rents are expected to decrease 3 percent. This is mostly due to the large number of new multifamily units currently in the pipeline. Warren notes that there is enough new construction under way to increase Austin’s apartment stock 8 percent — one of the highest numbers in the country.

“But you have to temper that with the fact this is Austin, and Austin — more than any other market in Texas — is the most resilient to negative factors,” Warren adds.

Ellen Muskin, a partner at Hendricks & Partners’ Austin office, is quick to add that her city has dealt with larger gluts of new housing in the past without long-lasting consequences. She says that from 1984 to 1986, the market saw approximately 40,000 units of new housing added to a city that had half the population it has now. In contrast, 17,000 new housing are slated for delivery in 2009.

“I think [the upcoming year] will be similar to times in the past when we’ve had a large amount of construction,” Muskin says. “There will be a bit of softening or, at the most, you will see Class A projects that are located farther out a little more affected.” Muskin adds owners in these areas are the most likely to give concessions in order to attract tenants.

Despite what many say, she believes that now is a perfect time to invest in real estate, especially in Austin. She says that you can still buy a multifamily property here for 50 percent of replacement cost. The lack of competition also gives those with the ability to acquire multifamily real estate a golden opportunity.

“People can shop online [instead of going to a store], but people always need a place to live,” Muskin says.

The next hurdle to jump may begin this year, as loans that were originated under the flawed fundamentals of the past few years come to term and find it hard to refinance under the current credit climate.

“I would expect owners of loans coming due in 2009 and 2010 to really struggle with the de-leveraging process,” says Hearn. “ As usual, though, one man’s pain will be another’s opportunity, so there will be deals that get done for sure.”

On the development side, things are not as optimistic. “One thing you’re absolutely going to see is new development slam to a halt,” Warren says. “In fact, I don’t see new development picking up to any degree probably until 2011.”

It is in 2011 that Hendricks & Partners has also predicted that there will be a national housing shortage. Texas will not be immune to this, but there are enough projects currently in the pipeline in the various markets to provide some supply. Once the credit markets thaw, expect a flurry of new multifamily projects to be announced.

With long-term population growth studies showing vast migration to the Sunbelt in the coming decades, this current downturn may one day be seen as a minor stumble in the state’s long-term growth. In response to this projection, some economists have even coined the term “Golden Triangle” in reference to the area formed by drawing a line from Dallas/Fort Worth through Austin to San Antonio, over to Houston and back to Dallas.

“That area is projected by some economists to be the fastest growing region nationally for the next 25 years,” Warren says.

As with the rest of the country, Texas will struggle this year. But with a stable multifamily market, an increase in population statewide and more companies deciding to call Texas home, the state appears to be on a clear track to a successful future.

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