FEATURE ARTICLE, MAY 2006

APARTMENT, INDUSTRIAL SECTORS SHINE IN THE LONE STAR STATE
Tim Speck, Michael Hoffman and Brad Bailey

A rapidly improving job market and continued interest from both local and out-of-state investors are bolstering the commercial real estate market in Texas. While the healthiest gains are slated to occur within the multifamily, industrial and office sectors, Marcus & Millichap expects to close more than $2 billion in Texas transactions this year.

Across the Lone Star State, the performance of the multifamily and industrial sectors will shine the brightest. The multifamily market is expected to experience robust expansion because of accelerated job growth, last year’s displacement of Hurricane Katrina evacuees and declining construction levels. Due to port expansion in Houston, the industrial property sector also is slated to make great strides in Houston, along the Interstate 35 Corridor and throughout the Rio Grande Valley. Although investors are still quick to invest in Texas office properties, development activity will moderate because of a construction materials shortage brought on by Katrina. Meanwhile, the retail sector will cool off after a white-hot 2005, with a growing number of crossover buyers having started to place their capital into multifamily product.

Austin Shines

Nowhere will the effects of an improving job market be more apparent than in Austin. The state capital is expected to expand at the highest rate in the nation this year, helping to draw more than 30,000 new residents. Employers will create 35,000 new jobs in 2006, a 5.1 percent increase after adding more than 15,000 last year.  Growth will likely continue at a rapid pace well beyond 2006 due to the recent announcement of Samsung, which approved the expansion of their operations by constructing a new $3.5 billion chip manufacturing plant.

In terms of multifamily investment activity, interest from local and out-of-state buyers will abound in Austin because effective rents and occupancy rates are rising. Meanwhile, cap rates for some properties have dipped below 6 percent. Properties are trading hands in some submarkets for as much as $100,000 per unit, up 10 percent from last year. Rental rates are expected to jump 2.5 percent and rest at $721 a month by year’s end.

Not to be outdone, strong growth among high-paying jobs and rising income levels of the Austin population are attracting several high-end retailers, thus placing upward pressure on retail property values. In 2007, Neiman Marcus and Macy’s will open their first department stores in Austin as anchors of the 675,000-square-foot The Domain in Northwest Austin. Local economists are predicting other retailers will soon follow suit. A significant amount of high-end space could be added to the market within the next 2 to 5 years as Austin continues to grow.

Evacuees Bolster Dallas/Fort Worth

In Dallas/Fort Worth, the displacement of hurricane survivors will give the region’s commercial property market an added measure of stability in 2006. Last fall, only Houston received more Gulf Coast evacuees than the Metroplex. This mass exodus had a profound impact on the apartment sector and also is boding well for the retail market.

In the weeks following the hurricane, apartment vacancy fell by almost 300 basis points as evacuees filled local properties. In addition to the short-term effects on market fundamentals, the diversion of building materials and construction labor to areas hit by Katrina is expected to limit multifamily development in Dallas/Fort Worth.

Recovery in the Metroplex is only beginning to gain real traction. Local employment is forecast to increase 3 percent, leading the country with a projected 82,000 jobs. This recovery will continue to draw a significant amount of capital to the market this year. While multifamily cap rates in Dallas have declined in recent years, the average still runs 100 to 150 basis points above the average nationwide.

Meanwhile, retailers are expecting sales to remain healthy as the local employment base and population grows at an accelerated pace. Developers will turn their sights on the construction of mixed-use urban transit projects that curb the use of automobiles. The city of Dallas’ comprehensive plan for future development aims to reduce dependence on automobile transportation by bringing employment opportunities and retail services closer to residential areas. The plan will focus on creating these urban, mixed-use developments near light rail stations in the Trinity River Corridor, the downtown area and the southern sector. 

In the southern part of Dallas, a new intermodal facility has taken flight, providing a boost to the industrial market. While land-locked Dallas doesn’t have a port, the city is still flying more air cargo out of the airport and bringing more goods and services up and down the I-35 Corridor.

The office market in Dallas/Fort Worth will continue to improve in 2006. Substantial activity in the upper-end of the market has boosted investment activity to near record levels. Just a handful of deals by institutional investors, such as JP Morgan and TIAA, comprised more than half of the total dollar volume last year. Reported cap rates on such deals have fallen to below 7 percent. In the lower end of the market, opportunities abound. While strong demand has also pushed cap rates down in this lower-priced market, the average remains favorable when compared to other major metropolitan areas. Those seeking the greatest stability in the marketplace may look for opportunities in the Fort Worth central business district (CBD), with its low 10.5 percent vacancy rate. There is potential upside in downtown Fort Worth due to the local government’s push to revitalize the area.

Houston’s Industrial Market to Expand

Houston is poised for record growth as thousands of displaced New Orleans residents opt to remain in the metropolitan area. As a result, Houston retail is poised to capitalize and the industrial sector will perform well also. To support this burgeoning demand, Marcus & Millichap of Houston plans to expand the number of agents in the field.

The Port of Houston is seeing a fair amount of growth as well as increased trade with Latin American countries, contributing to an improved industrial property sector. The Southeast submarket, which serves the Port of Houston and also the petrochemical industry, will continue to outperform the market, as it did last year when vacancy ended 2005 in the mid-7 percent range. Major retailers like The Home Depot will continue to establish distribution centers in the submarket, a trend expected to persist for several years. The east side of the metro area is the focus of investors looking for greater appreciation potential, but some of those seeking more stability and comparatively better cash flows are focusing on the Northwest submarket.

Meanwhile, significant expansion in the energy sector will spur an ongoing recovery in the Houston office market. Area powerhouses, such as ExxonMobil, ConocoPhillips, Shell Oil and Citgo, are enjoying robust business growth. Downtown owners will also see a welcome economic boost this year, as vacancy is forecast to drop 320 basis points during 2006 to 16.4 percent.

The investment climate remains heated as more out-of-area investors flock to Houston’s office market. The sale of high-end properties, such as the Reliant Energy Plaza, has helped push down cap rates. More buyers are willing to pay a premium for local properties, even though cap rates have fallen during the past year. Investors seeking to capitalize on Houston growth trends should focus their efforts on the western area of the city.

Office Investors Eye San Antonio

Turning to San Antonio, the city’s resilient economy will set the stage for continued improvement in the commercial property market, particularly in the office sector. Large-scale corporate expansions are continuing, with recent announcements from Washington Mutual and Toyota. WaMu will add 4,200 jobs at its facility located on the border of the Northwest and Northeast submarkets during the next few years, spurring other companies to expand as well. Toyota is building a large-scale truck plant in the small South San Antonio submarket that will employ 4,100 workers. While these are mainly manufacturing jobs, support positions will likely be created in the area, which will boost demand for local office space. The Northwest San Antonio submarket will realize the greatest gains in effective rents, with an increase of 3.6 percent predicted. Despite having more planned construction than any other submarket, the Northwest submarket’s vacancy rate will decline 200 basis points this year to 12.5 percent.

Private investors continue to dominate the San Antonio office investment market, accounting for approximately 70 percent of all transactions last year. Cap rates compressed to an all-time low of 7.9 percent in early 2005, yet have remained relatively constant during the past 12 months.

After hitting a peak in 2004, apartment vacancies are beginning to decline. New construction is expected to decline 30 percent this year. The core apartment investor will find the market provides a unique combination of stability and yield. The area continues to prove its muster by attracting large employers.

Multifamily cap rates appear to be stabilizing again after dropping for several years, which has attracted more investment capital to San Antonio’s marketplace. In particular, an increasing number of California-based investors will buy apartment properties.

While local investors will maintain a strong presence throughout the major Texas markets, buyers from Southern California and the upper Midwest, including Chicago and Detroit, are expected to flex their spending muscle this year. At the same time, buyers from the Northeast, who already own southwestern real estate holdings, are expected to maintain a noticeable presence in Texas. Although the retail and office sectors may lag the performance of their apartment and industrial counterparts, overall commercial property market conditions will remain healthy in 2006.

Tim Speck is vice president and regional manager of the Dallas office of Marcus & Millichap. Michael Hoffman is vice president and regional manager of the Houston office of Marcus & Millichap. Brad Bailey is regional manager of the Austin and San Antonio offices of Marcus & Millichap.

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