COVER STORY, JULY 2007

LENDER’S POINT OF VIEW
Houston is a hot market for smart borrowers and investors.
Elaine Opper

Opper

Houston’s commercial real estate market continues to stand out as a good bet in the short-term and foreseeable future as it lies in the Southwest demographic growth region, has many unique attributes and is the fourth-largest metropolitan area in the country. As lenders with years of experience in the area know, the rebound and continued growth in the market the past 15 years has been nothing short of spectacular for developers, investors and lenders, as well. All have been the beneficiaries of steady job growth fueled by a more diverse economy than what Houston experienced before the 1990s.

The expansion and corporate consolidations in the energy industry, Houston’s medical center complex with its proximity to the Johnson Space Center and the expansion of the Houston Port facilities, as well as ongoing residential and commercial construction and major highway construction capital improvement projects, have all contributed to the local economic expansion and job growth.

In today’s environment, Houston’s office market continues to show positive absorption and lower vacancies in certain submarkets such as the central business district (CBD), Westchase, Interstate 10 West and The Woodlands areas. Many corporate tenants have mandates to lease space in office buildings that are certified green buildings, so this will likely become more standard on newer office projects in the Houston area. New industrial warehouse development activities have picked up in the North, Northwest and Southeast (near the Houston Ship Channel due to the increased container activity and recent expansion of port facilities) submarkets of Houston. While more speculative office and warehouse space is coming on line during 2007, most of these projects currently appear to be in strong submarket areas where demand remains high and very little inventory exists.  

The trend for additional multi-use retail, office and multifamily projects has taken hold in the Houston metropolitan area, such as The Woodlands Town Center, Sugarland Town Square, Midway Development’s Town and Country Mall redevelopment and New Quest Properties’ Brazos Town Center in Rosenberg. Evidence of the success of this concept can also be seen in the recent announcement of the Houston Galveston Area Council’s $68 billion 2035 regional transportation plan that calls for the creation of seven new livable centers using transportation decisions to influence the form and location of the developments. If successfully executed, this plan could present future opportunities for commercial and residential development, as well as job creation.

Despite Strong Market, Soft Spots Exist

This is all good news, but wise developers and investors — as well as lenders — should be on the lookout for some potential soft spots in the Houston market. There has been a recent trend of lower pre-leasing requirements on many commercial real estate construction projects in the Houston area. Borrowers and lenders should not be sponsoring the development of speculative projects that are not well located within tight vacancy submarket areas. In a market like Houston, it is imperative to keep an eye on other development projects that are coming on right behind yours, which could potentially impact rents and vacancies. In heated markets, there is an old saying, “There is more money than sense out there.” Now is the time for borrowers and lenders to take a reality check.

As long as the greater metropolitan area continues to have strong job growth, Houston’s overall residential market should remain healthy. Fortunately, Houston did not have large investor activity in residential housing like the Florida, Arizona, Nevada and California markets. Be mindful, though, that there is some current softness in the entry-level residential segment due to mortgage lenders toughening up residential mortgage application standards, a byproduct of the sub-prime mortgage fallout. However, residential developers with starter home subdivisions that are well located near good schools will continue to do well. The mid- to higher-end homes will remain very much in demand in Houston.

Another segment that is likely to experience softening in the next 12 months is unanchored strip retail centers in some of Houston’s outlying suburban areas. However, with the right location in Houston (especially inside the Loop 610 or inside the outer beltway), retail strip centers continue to have no problem finding tenants. Each developer and investor just needs to make sure that the prospective multi-tenant retail center location is very strong.

All astute commercial real estate developers, investors and lenders must be mindful of land prices, too. Houston has been seeing a steady rise in property prices, most dramatically inside the Loop 610, but also inside the outer beltway and beyond. Increases in real estate costs are always a key signal that the market is changing. The question for developers, investors and lenders is whether this change will ultimately work for or against them. It’s tough to make up for overpaying for land because rents can only be as high as the market will bear. 

This has been a borrowers market, where higher-leveraged, one-size mortgages have fit all projects. As a result of lenders allowing the same level of leverage on higher-risk projects, there could potentially be some fallout for borrowers and their investors even in a strong market like Houston. With higher leveraged properties, there is just too little cushion and more risk. If pro-forma rents are not achieved or operating expenses rise faster than rental income, debt-service coverages can and will erode quickly.

Sound Fundamentals Are Key To Good Investments    

Developers, builders and investors must be cautious against overbuilding in this environment. For banks, this means that they need to be more disciplined in conducting their due diligence on the borrowers. Special attention needs to be paid to their development and management capabilities, as well as the overall project and specific submarket location before making loan decisions.

There is no substitute for experience and local knowledge when it comes to timing and seizing opportunities, either to buy, develop or sell properties; that’s fundamental for making good investment and financing decisions. Many less experienced developers and investors, as well as lending groups, will fail to see the weak areas causing them to make unsound decisions when debt and equity are plentiful in a market like Houston.

Borrowers that recognize the value of sound fundamentals in investing will do fine as there are opportunities for continued development here in Houston. It is true that developers seeking project financing today have more options, but there is no substitute for financial partners that understand the market and the borrower’s business, have been through the market’s ups and downs and share the same business philosophy. Working with an institution that can properly advise and tailor a loan structure can often spare a developer and investors financial pain later.

Overall, Houston’s commercial and residential markets will remain a bright spot among a handful of major metropolitan areas in the country during the second half of 2007.

Elaine Opper is executive vice president, real estate, with Texas Capital Bank.


©2007 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.