COVER STORY, NOVEMBER 2011

SHOWING SIGNS OF STRENGTH
Healthy fundamentals and new construction abound in Houston and Dallas/Fort Worth’s multifamily markets.
Compiled by John Nelson and David Dozier

The multifamily market in Houston and Dallas/Fort Worth is enjoying strong vital signs in the recovery period of their respective economies. With that in mind, Tony Gray and Bill Jackson of NorthMarq Capital have provided Texas Real Estate Business magazine with first-hand knowledge of their multifamily markets.

Houston

Last year’s green shoots have turned into towering trees in the Houston multifamily market. Reis estimates that Houston metro vacancy has decreased from 12 percent market-wide during the darkest days of the 2009 recession to 9.7 percent today. Reis has also projected that vacancy rates will fall below 9 percent market-wide by year end, trending to 7.8 percent by 2015.

As vacancy trends have remained highly favorable, rental rates have followed suit. Reis estimates that Houston metro rents have
increased approximately 6 percent since mid-2009, and rents are expected to increase approximately 3  percent per year through 2015. These steady rent and occupancy trends have been fueled by robust supply and demand factors. Reis estimates that Houston has seen 14,200 units of absorption in the past 12 months. The company also forecasts absorption of more than 6,200 units annually through 2015, which will further decrease vacancy rates and provide a platform for further sustainable rental rate growth. All of these positive trends have opened the door to a wave of new development.

This year should be anointed as “Houston’s Year of New Development.” Many recently announced developments are already under construction and will begin delivering units in mid-2012. The institutional investment community has determined that Houston represents one of the country’s best bets for new development, especially within the multifamily sector. Houston’s robust job growth has been the city’s calling card to attract capital. The Greater Houston Partnership estimates that Houston added more than 65,000 jobs between August 2010 and August 2011 alone.

The first round of new development is being led by multifamily developers with a national footprint including Greystar Residential, Alliance Residential and Mill Creek Residential. This developmental renaissance is also being fueled by top local developers including Grayco Partners, The Dinerstein Companies, The Morgan Group and Martin Fein Interests. Developers are drawn to the Houston market because they can achieve proforma returns on cost ranging from 7 percent to 8 percent, creating a lift of 200 basis points over current Class A selling cap rates of 5 percent to 6 percent. Class B projects are generally trading hands at stabilized cap rates of 6 percent to 7 percent. Given the lack of new multifamily deliveries during the past 24 months and the limited delivery expected during the next 12 months, Houston apartment owners should continue to enjoy increasing rents, declining vacancy and a sustainable multifamily market.

— Tony Gray is the vice president and producer in NorthMarq Capital’s Houston office.

Dallas/Fort Worth

Dallas/Fort Worth multifamily fundamentals are strong and poised to get stronger. The improving economy and the relative lack of new construction has allowed vacancies to come down and rental rates to increase, and dramatically so in some submarkets (i.e. intown Dallas, far North Dallas, Plano, Las Colinas/Coppell, Frisco/Prosper and intown Fort Worth).

Overall occupancy is more than 93 percent and climbing and the local economy is projected to have some of the strongest job growth in the country. According to the DFW Apartment Report from MPF Research, the last 12 months saw the delivery of 5,189 units and the forecast for the coming 12 months is 5,333 units.

Compared to the rest of the country this is quite high but it is still well below the average of around 13,000 units completed annually since 2000 and actually represents a 16-year low. So, deals are getting done but not at a pace to overreach forecasted absorption. This has allowed fundamentals to recover quite nicely and strengthened the appetite of permanent lenders and equity providers.

One would think that construction lenders would be making a number of new construction loans in Dallas/Fort Worth. And in some cases they are, but the transaction has to be the right deal and with the right sponsor who has few legacy issues. Banks have been cautious as we have exited the recession, which will likely allow for an even longer period for fundamentals to recover.  Multifamily construction loans are either being limited to best in class sponsors and locations or low leverage deals (usually all of the above).

Permanent lenders, especially Freddie Mac and Fannie Mae, are closing large production loan volumes during 2011 in the north Texas multifamily market. Life insurance companies have been very active competing with the agencies and winning its fair share of business. In many cases the life companies are beating the agencies on multifamily deals.

Both Freddie Mac and Fannie Mae are staffing up for the future. They like what they see in the multifamily market and especially the Dallas/Fort Worth market. Coupled with their positive outlook is their equally attractive cost of funds. These two government-sponsored entities have the luxury of having the implicit guaranty of the federal government so they can sell mortgage-backed securities (MBS) at tighter spreads over the corresponding treasury than Wall Street can. And both companies have taken advantage of this and moved away from a model that focused on balance sheet lending to a model that focuses on securitized lending. So, CMBS is back at least with Freddie and Fannie.

The CMBS 2.0 business model also seems to be stabilizing after the S&P rating snafu and market meltdown of several months ago. It has money available and is attempting to rejoin the competition for multifamily mortgages. CMBS 2.0, as it is now referred, is back to where we were in the early 2000s with the main problem of not knowing the final loan terms until several days prior to closing. Although CMBS 2.0 is back, rates are 50 to up to 200 basis points higher than the agencies and life companies, so they are not competitive at the moment.

— Bill Jackson is the senior vice president and managing director of NorthMarq Capital’s Dallas office.

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