FEATURE ARTICLE, SEPTEMBER 2011

TEXAS MULTIFAMILY ROUNDTABLE: VIEWS FROM THE BROKERS

The following professionals participated: Jim Hearn, partner, Hendricks & Partners’ Houston office; David Luther, regional manager, Marcus & Millichap’s Houston office; David Oelfke, principal in ARA’s Houston office; Tim Speck, first vice president and regional manager, Marcus & Millichap’s Dallas office; and J. Michael Watson, regional manager, Marcus & Millichap’s San Antonio office

Texas Real Estate Business: In what markets and for what type of developments are deals getting done? What are some of the largest multifamily sales that have occurred in 2011?

Oelfke: I would say that there’s not any market and not any type of multifamily properties that aren’t getting done. I think the breadth of activity is really from the best to the very worst. Most demand from what we’re seeing and what people really want today are the really well-located projects. If you have a high-end core asset there may be less demand but still very good demand, but if you got a really well-located asset that has a story whether it’s who the owner is or a value add opportunity or whatever it might be, that’s when we’re getting 30 tours and 30 offers so. There’s a buyer for every deal for the most part as long as its priced in a range that makes sense.

Verde sold a large portfolio of properties in Texas that Camden purchased. Other than that there’s been a couple of C-asset portfolios that have sold. As far as closed there hasn’t been any large portfolio that’s sold that I know about in Texas. The challenge today with the big deals is that they require a lot more equity than they did 5 years ago. There’s some limitations to some extent. There’s tons of money that needs to get out so the demand is there. It just makes it a little more challenging than back 5 years ago when there was a way to structure transactions with less equity.

TREB: What is the status for multifamily development activity in Texas markets? What areas are hot and for what type of product? For what reasons?

Watson: Apartment development is accelerating across Texas to meet strengthening demand. The national downturn in housing has limited financing capacity in Texas for potential homebuyers, supporting demand for apartment units. In Austin, areas at either end of the NAFTA bypass are positioned to receive thousands of apartment units in the next few years as part of large master-planned communities. Nearly 19,000 units are planned for the metro and surrounding areas. In San Antonio, meanwhile, only 6,100 units are planned and most of them are on the northern side of the city near State Highway 1604.

TREB: What are the challenges you’re seeing with financing for multifamily properties — both for transactions and development?

Speck: The further from Class A properties in core locations, the more difficult properties are to finance. As an example, Class C and/or distressed properties that are in secondary or tertiary markets can be a big challenge.

The changes, and therefore challenges, in financing multifamily properties have been that lenders have a renewed focus on the strength of the sponsorship with respect to liquidity, net worth, management experience, real estate-owned schedule and the overall performance of a borrower’s portfolio. Recently, we have seen lenders pass on providing financing to experienced clients that meet all of the so-called credit hurdles; however the lender’s concern was with potential refinance risk of the over-leveraged real estate in the borrower’s portfolio.

In regards to development deals, Class A multifamily projects in core markets are the easiest to get done. However, lenders are wary of merchant builders, as these were the relationships that hit the banks the hardest in the downturn. Banks want to deal with borrowers who have proven they can successfully carry their projects. In order to get conventional financing approved the project needs to be in the right location with the right sponsorship.
TREB: What types of properties and what markets are still struggling? For what reasons? How has the economy affected the current multifamily real estate market across Texas?

Luther: Simply put, the further from Class A, core infill to Class C/D secondary/tertiary markets, the more investors will struggle. The reason for the challenge is directly correlated to the amount of investors willing to invest in that product. Currently, the amount of capital willing to invest diminishes exponentially as you get to the outer rings of class and geography. The real positives are that velocity has picked up considerably in 2011, with the availability of financing again playing a big role. Additionally, there has been a big focus on value-added opportunities over the last couple of years but with interest rates being so attractive, investors are starting to reevaluate stabilized assets and will take advantage of the historically low interest rates to realize some good returns and hedge against the future uncertainty of taxes and inflation.

TREB: How are occupancy rates faring in different markets? What are the challenges the multifamily sector is facing when it comes to filling units?

Hearn: Across Houston, the Class A market continues to flourish with impressive trends in both occupancy and rent; the lower class buildings continue to struggle except in the most favorable areas. It’s just my opinion, but Houston has an incredible supply of functionally obsolete buildings.  It’s hard to see a clear path for removing all of these units at once, but you could raze 25,000 apartments and hardly miss them. We have many areas across the city with large clusters of buildings.  As we have seen in several past economic downturns, these areas tend to decline rapidly and return slowly.  Investors are lured to these areas by low prices, but most struggle as operators because you can’t turn a neighborhood around by improving one property. Historically it has taken a long time for the bottom of the market to rebound even when the top is making impressive gains.

Oelfke: The occupancy rates are really good across the board, certainly in the Class A sector. Most properties are 95 percent occupied and up to 99 percent leased. There’s tremendous strength in the occupancy of well-located Class A properties. When you step down into the Class B and Class C or lower, Bs are okay, they’re still struggling. But as the market continues to improve I think those properties will follow suit. They’re not any comparison to what the As look like today.

Primarily the properties have to be well maintained, or at least maintained in a way that the more affluent tenants feel like it’s a place they could live. Secondly, as you look into these different submarkets where the demographics haven’t improved or gotten worse, there’s a sense that they’re not very safe. Security is kind of a four-letter word in the industry but there needs to be a sense of a secure environment. If you have a well-maintained C property that has some sense of security with a safety factor to it from a resident perspective then it’s probably going to outperform.

TREB: What are some of the different trends you’re seeing for condos, apartments, student and senior housing?

Luther: Apartment construction has plummeted, despite the relative ease of building in Texas. Financing for new complexes is only now beginning to recover, and development will begin to accelerate in 2012. Nonetheless, the supply/demand imbalance that favors owners will hold up until 2013, unless the global financial markets drag the U.S. into another recession.

Condo and townhouse development is accelerating, though the overall number of units that will be completed is minor compared to inventory. Less than 2,000 for-sale units are slated for completion across the four major metros in Texas this year, after less than 1,000 condos were finished in 2010.

Oelfke: I think there’s some great fundamentals and momentum in every sector. Student housing has really picked up nicely. And it’s really due to Houston not having much supply, if any, in any of these products. If you look to the demographic trends, kids are getting out of college and for the past couple of years they’ve lived at home or they doubled up because they didn’t have a job or feel comfortable with their job. In Houston we’re having higher job growth and there’s a higher degree in confidence, so they’re moving out of their parents’ house and renting apartments. That’s a fundamental change that’s affected the market. When you talk about some of the special housing groups like student or senior I think they follow suit in a little bit different way. It’s supply and demand. If anything the supply has been not increased and you have demand in all sectors that has increased. The result of that is occupancy has stabilized dramatically, concessions are starting to be pulled back in every sector and rents are starting to move. There’s an information source in Houston called ADS (Apartment Data Services) and they’re suggesting that over the next 3 years, certainly in Class A, rent will grow 25 percent. Some of them believe the rent growth projections that people are using could be way too conservative. Time will tell but I think if you look at where things are heading, people don’t want to get too exuberant but I think there’s a real chance that we could see some great growth across the board. People have been very careful with their locations and what their expectations that they can do to create value in the properties. If they execute well I think they’ll do very well.

I think the portfolio side has become much more active because there’s a stable of groups that have money that needs to get placed and if they can do it in larger chunks than it’s attractive. At a time when you did a large transaction, the debt would be dramatically better, especially when the banks were active in the CMBS market. Generally speaking, banks had more attractive debt for larger transactions. I don’t really see that driving it at this point. I think loan-to-values are driving the pricing more than the size of the transaction. There’s definitely an improvement in that. As the markets continue to show dramatic improvement I think it’s just going to drive more capital to them and I don’t see anything that’s going to slow down the pricing and the cap rates being paid. There’s a lot of turmoil in the capital markets right now but I don’t see that dramatically changing things in the multifamily sector.

I think some of the markets that are seeing job growth like Texas, the Carolinas, to some extent Florida and the Northeast. I think there are markets that are going to continue to stay active. The benefit in investing in these markets is having interest rates low because economic expectations for the country are still muted. Until the economics in this country turn around, it’s a great place to be investing. If at one point when the rates come back, it’s going to be a great time to invest for people who are strategic in what they’re doing. It’s as good as I’ve seen it in a long long time. I’d hate to say ever but it probably is ever.

Speck: Senior housing is only beginning to stabilize. Most seniors sell their home before transitioning into independent living units, which has proved difficult due to the struggling national housing market. In addition, low interest rates have reduced the growth rate of retirement investments, causing hesitation among many potential retirees. Assisted-living and skilled-nursing facilities, meanwhile, are slowly recovering in the wake of the recession. Development in this segment will fall by approximately 50 percent in Texas this year.

Student housing development is rising, but the total number of units that will come online is modest and have little impact on apartment demand near major universities.

Watson: Condos are beginning to recover in Austin and San Antonio, though most renters are content in apartments. Due to volatility in prices, potential buyers are more likely to rent or make a transition to a single-family home in these cities.

Student housing remains popular in Austin and San Antonio, where several hundred units are planned for each metro. The potential of overbuilding in this segment remains high, however, as education costs skyrocket, reducing potential demand for students.

Seniors housing has stabilized across the country, including in Austin and San Antonio. Independent living is the weakest of the sectors as potential retirees wait out the dismal housing market in the Northeast and Midwest. Entrance-fee child care resource centers have struggled for the same reason, while assisted-living and skilled-nursing facilities are beginning to experience leveling demand.

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