COVER STORY, OCTOBER 2010

INVESTMENT RISING
Investors are looking to multifamily as a sound strategy.
Hendricks & Partners

One of the nation’s hottest spots for multifamily investment, Texas is poised for strong growth, having struggled much less in the economic downturn than many other states. Unemployment in the Lone Star State remains in the low 8 percent range, and non-farm employment totals have already returned to mid-2007 levels. Texas’ bright outlook is attracting a high level of multifamily investor interest to the state’s major markets, with a variety of investors, from institutions to entrepreneurs, in search of everything from prime luxury properties to those in need of extensive renovation.

Dallas/Fort Worth

The DFW area is showing signs of strengthening, and investors of all types are taking notice. The reasons for this are twofold. Mainly, as Texas and DFW did not experience the meltdown the rest of the country did, there is no catastrophe bias against the area. Second, the DFW area is experiencing job growth — 1.3 percent year-over-year in July 2010 — and employment equals renters.

Any multifamily property that is brought to market is receiving increasing interest and offers. A recent example is a 225-unit asset that received more than 100 confidentiality agreements and close to 40 offers. Investor interest is coming from all areas of the country and from the entire spectrum of buyers. Of note is the fact that a very significant percentage of current investors are new to the area. We’re seeing a whole new crop of investors who like the DFW story going forward. Again, it all comes down to jobs and the forecast that DFW will be one of the country’s job growth leaders during the next several years, led by the professional and services sector. In fact, the region is projected to add 3 million new residents and 1.5 million jobs between 2010 and 2030, according to the North Central Texas Council of Governments.

Three distinct types of investor interest are apparent in the market. The first two are seeking apartments at either end of the class spectrum. In other words, there is a lot of money chasing trophies and train wrecks. Both are essentially bought on a price-per-pound basis. Class A investors, both institutional and private, justify the significant cap rate compression as buying below replacement cost in great locations. The third type of investor remains the yield buyer who seeks a return on his capital; requirements vary widely across the spectrum. In the current environment of rising prices and cap rate compression, the yield buyer is consistently getting left empty-handed when competing with the price-per-pound investor.

The future is bright for the area and for its apartment market unless further national economic turmoil derails the whole country. The next 6 to 18 months should be a clear upward trend, but beyond that is anybody’s guess. DFW is notorious for overbuilding and, as soon as developers and lenders get cozy enough with the future, there is no doubt construction will begin again.

— Tom Warren, partner

Houston

The biggest trend in the Houston investment market right now may be the trend that never happened. Two years ago, investors were setting up shop for the flood of lender deals that were expected to hit the market, and yet that flood of deals never materialized. The servicers have moved more cautiously than expected, and forbearance agreements and loan restructuring have kept many deals alive much longer than originally projected. It is possible that the servicers will need to begin selling a larger percentage of the deals they control, but it is pretty clear that we are not going to see mass amounts of assets like we did around 1990. Lending has also loosened up a shade, and with rates low, some refinances and recapitalizations that did not seem feasible a short time ago have actually taken place.

Multifamily investors are hungry for Houston assets, and the most recent closings reveal a thirst for both high- and low-quality properties. Pent-up demand to deploy capital has a significant number of institutional investors chasing a small supply of Class A assets, while an equal number of private entrepreneurial types are snapping up cheap deals sold by lenders or special servicers. Long-term projections for population and job growth are quite favorable — according to a recent report from the University of Houston’s Institute for Regional Forecasting, Houston will see the addition of 3.7 million people and 1.5 million jobs during the next 25 years. Keeping these projections in mind, investors like the opportunity to buy at depressed prices with a quicker chance for an overall rebound.

A prime location, a comparatively strong job market and a much softer fall during the downturn have kept Houston on the radar of many national investors. Because of the size of our existing apartment supply and population, we have a variety of buyer types. Investors range from institutions chasing expensive infill assets to a plethora of smaller private capital investors looking for lender deals where prices per unit are as low as or lower than they were in the late 1980s. There’s been a lot of activity at the high end of the market, with institutions paying cap rates of 5 percent and lower for properties. There is a strong belief that when the market rebounds, these assets will be well-positioned.

— Jim Hearn, partner

San Antonio

The San Antonio market continues to garner a great deal of investor interest. As things unraveled in 2008, we took a dip in not only transaction volume, but also interest; however, the attention has cranked back up, as investors are seeking not only stable economics but also pricing by weight. “Stability” is a word that has described San Antonio for many years, and due to our relatively positive job growth and the fact that we did not fall as far as other markets, we can still use this term to describe our market. Investors are looking for this stability, which includes relatively consistent returns and healthy demand on an exit strategy.

An element that seems to be missing from past market trends is the small California investor. For the most part, however, the investor pool today is made up mainly of the same groups from the past. They are seeking larger properties of 100 or more units, are well-funded and many already own in this market, having invested over the past decade. The advantage for these investors today is better pricing on assets similar to what they already own, as well as the ability to obtain record low debt on healthier assets. Large institutional pools are coming in, often offering all cash to get deals, as well as the well-funded partnerships, many with household names in the business.

Investors are looking for double-digit, cash-on-cash returns in the high teens or low twenties on an IRR basis as well as below-market pricing. In fact, “market pricing” is a relative term right now — as things are recovering, we are seeing pricing by asset class fall more in line with where it probably should be on a class-to-class basis.

San Antonio is still constrained by a lack of product for sale. We will see fundamentals continue to firm up and property performance return to a level that may allow some investors to get the returns they were seeking prior to 2008. The lack of new construction is resulting in more competition for existing rentals, and concessions and vacancy rates continue to fall. The result hopefully will be more sellers taking advantage of market conditions and choosing to sell.

— Mike Miller, associate partner

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