FEATURE ARTICLE, MAY 2009

THE LONE STAR?
An analysis of Texas’ commercial markets and why they continue to outshine the rest.
Farley Dakan

As the depth and breadth of the current recession becomes increasingly evident, one thing is apparent: no one is immune. While some regions of the country have clearly taken a harder hit than others, and there are clear market-specific differences when it comes to who has borne — and who will continue to bear — the brunt of the impact, virtually everyone is experiencing some kind of significant repercussions.

For real estate developers and investors everywhere, the short- and long-term impacts of what began as a subprime mortgage crisis, and has now evolved into a full-scale economic slowdown, are being keenly felt. With the number of acquisition, development and construction loans reverting back to their books, banks and lending institutions are facing new challenges. As the developer exits the scenario during distress, banks are finding that they lack the expertise and localized intelligence to value and manage these assets. Real estate investors find themselves in a similar conundrum when looking to purchase a portfolio. Considering the relative speed with which this asset class can enter into freefall, an accurate answer to the value question marks the difference between a strategic investment and a disastrous move. But what can localized intelligence tell investors about the opportunities specific to key markets in this state?

On the surface, Texas appears to have held up relatively well in recent years. It is a well-known cliché that everything is bigger in Texas and, even today, that includes the state economy, which is growing at a rate that significantly exceeds the national average.

It is not just the economy that is growing. Houston, Dallas/Fort Worth, San Antonio and Austin are all among the fast growing metro areas in the country. Data from the 2008 census reveals that, as of 2007, 11 of the top 25 fastest growing counties in the nation were in Texas. These markets are also incredibly diverse, with a strong presence in a variety of industries, including energy, shipping, manufacturing, agriculture, education, technology,  real estate, hospitality, and transportation.

Understanding how the current national slowdown is impacting the Lone Star State, and getting a better feel for how Texas will fare in the months and years ahead, can provide some new insights and valuable perspective, not only about the future of this important state, but also about the underlying dynamics driving the current slowdown and how the national economy as a whole will respond to those forces in the years ahead.

The degree to which Texas was slow to feel the impact of the first real estate tremors is significant. As far back as 2005, many parts of the country began to experience a slow decline in real estate values. That decline would accelerate as the full force of the subprime mortgage crisis acted like a spark on the dry tinder of an over-leveraged residential housing market. In Texas, however, values held.

The reasons for that initial resilience are many, but the most significant factor was the influence of that iconic Texas asset: oil. The historic influence of petroleum on the state’s economy cannot be overstated. In fact, Texas’ state economy has actually paradoxically improved during some past national recessions, partially because of the counterweight impact of the oil market. Today, with the oil market eroding in response to plummeting prices, the trickle-down effect is finally being felt in Texas real estate. Not only will the job losses have an impact, the decrease in oil value will cause overleveraged petroleum-based lending activities at some Texas-based banks to domino into the strength of their balance sheets.

Because Texas did not have nearly as significant of a speculation-driven run-up in property values as many areas of the country experienced, the Texas housing market stayed somewhat in check. Housing and land prices stayed relatively low, and the resulting shock of the real estate crisis originally was felt less. Only now are many distressed assets really hitting the market; owners and managers of buildings predicated on pre-sales are realizing that those pre-sales are not “real”. While the strong will survive and quality properties and great developments will do well, there is an oversupply coming. Because of global problems with the banking system and the difficulties of homebuilders in other markets, many developers have been “relying” on Texas for quite some time, and that is about to change. For those looking to invest in these upcoming distressed assets, historical reference will not provide insight as the state’s mixed-use and land developments are on the precipice of a decline. 

The discount that is being taken by stakeholders is greater in other markets, but their run-up was also correspondingly greater. The result is that the Texas market will resemble a muted version of that experienced throughout the country – and the timeline will be somewhat staggered. There will be opportunities in Texas in the future, but those opportunities will likely lag somewhat behind the rest of the country. The margins in Texas will tend to be lower – there will be lower peaks, but also lower valleys – and the investment horizon will be somewhat further down the road.

The bottom line is that Texas will certainly suffer somewhat as a result of the national over-valuation of real estate. Despite the state’s robust tradition of “riding out” national recessionary cycles with relative impunity — with the notable exception of the Savings and Loan Crisis — no one is immune from this current crisis. In a sense, there is a smaller margin for error in the state because of tighter margins, and the Texas job market will almost certainly take a hit as well. It is important to remember that the state’s size and complexity makes broad conclusions marginally useful. While it is impossible to “know” precisely how these various markets will react, the different demographics and market forces at work make it possible to make some educated guesses. Credit fueled Houston and Dallas, with their capital-markets-based economy and reliance on the oil market and real estate markets, will most likely be hardest hit. San Antonio, which is primarily government based, will likely be a little bit more resilient, and while Austin’s tech-based economy should do okay, the city will suffer from what has been an overbuilding of downtown, condominium-style residences.

While there are grim realities to be faced, some Texas-style optimism remains. Despite the fact that the state’s commercial property sales numbers are down almost 50 percent from 2007, it should be noted that, relative to the national numbers, Texas’ overall development landscape is actually looking quite respectable. In fact, in August of last year, the Dallas Business Journal reported that for the fourth year in a row, a recent survey of nearly 300 corporate executives found that Texas is viewed as having the best business climate in the nation. Such positive indicators are seen by many as a sign that, while challenges certainly lie ahead, Texas will ultimately demonstrate its economic resilience and real estate markets across the Lone Star State will not take long to get back on top.

Astute real estate investors will look past the headlines and recognize that distressed asset opportunities will present themselves in Texas over the next 18 months — and the question of true value can only be answered by those with boots on the ground. Cowboy boots, of course.

Farley Dakan is a managing partner in Austin, Texas-based GreenAcre Partners.

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