TEXAS SNAPSHOT, JUNE 2010

Dallas Multifamily Market

The Dallas/Fort Worth job market is outperforming the nation this year. After cutting 124,000 positions during 2008 and 2009, local employers are forecast to add 66,000 new jobs in 2010, led by gains in the education and health services, and professional and business services sectors. As job losses escalated over the past couple of years, local residents responded by doubling up, which weighed on apartment fundamentals. As the economy gains steam throughout 2010, this trend should begin to reverse, leading to a choppy recovery in overall occupancy levels.

Apartment owners in high-end submarkets near major employment centers continue to slash rents and widen incentives to attract renters. In the five submarkets that registered double-digit revenue drops, vacancy climbed by more than 300 basis points, compared with a marketwide increase of 240 basis points. It comes as no surprise that new construction combined with job losses is what drove effective rents down along with occupancy. However, as the local employment base gains traction, absorption in these areas will accelerate as renters transition into discounted premier units; this will leave behind a glut of Class B units. Despite incentives, demand for these mid-tier units will not come from Class C users moving up to better accommodations until 2011, when employment and household growth gravitate toward strong-economy levels. Competition should weaken among Class B operators in the second half of the year.

New apartment construction in Dallas/Fort Worth will slow dramatically this year, but the impact of last year’s surge in deliveries continues to linger. The spike in new supply last year coincided with significant job losses, causing an increase in vacancy and significant rent reductions, which in turn resulted in a growing number of distressed properties. Class A properties in the marketplace posted positive absorption through the recession, but the absorption came at the expense of rents and concessions. More Class A distress will emerge this year, particularly in suburban mixed-use projects that encountered significant difficulties at lease up. A few Class A foreclosures have occurred in recent months, but they have been scattered across the metro area. As rents slipped for local apartments, many renters upgraded from Class B units, leading to significant softening in the lower tiers of the market and mounting distress in East and Southeast Dallas.

Investor interest in Dallas/Fort Worth apartment assets is gathering momentum, though acquisitions will be focused on a select group of available properties. Listings valued between $3 million and $8 million with fewer than 150 units remain the most desirable due to available Freddie Mac and Fannie Mae financing. Buyers seeking properties outside of this segment have significant negotiating leverage and are forming syndicates to raise capital. In addition to local groups, coastal investors are switching product focus and re-entering the market to take advantage of attractive cap rates and healthy demographic projections. Cap rates average near 8 percent, though investors may have to account for as much as 3 years of deferred maintenance when underwriting and valuing properties. Many well-capitalized owner/operators are seeking to take advantage of management-intensive opportunities listed by out-of-state owners attempting to exit the market. As a result, eight- to 30-unit deals also will remain prevalent, with distressed and value-add multifamily properties garnering the most attention.

In 2011, the Dallas/Fort Worth apartment market should stabilize, as economic conditions improve and the current moratorium on building remains in place due to the tight credit markets. A brief imbalance between supply and demand should support healthy rent growth until development activity resumes in the second half of 2011, brining the market into an equilibrium that could last until the next recession. Builders in the Metroplex are renowned for bringing new units online, however, and an earlier thaw in development lending may boost activity sooner, limiting the window that owners will have to significantly improve NOIs. Nonetheless, some developers may face a longer ramp-up time due to the significant cuts in their workforces that were made during the height of the most recent recession.

— Tim Speck is the first vice president and regional manager of the Dallas office of Marcus & Millichap.

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