Houston‘s apartment market began to gain some momentum in early 2005, when demand suddenly surged to more than 20,000 units during the first half of the year. A strengthening economy helped fuel this upturn in absorption. Annual employment growth was up to 28,000 jobs, a 1.2 percent expansion, by the middle of the year. While hiring was widespread across many industries, the energy sector took an especially notable upswing when oil prices climbed to record levels throughout the year. Further boosting the apartment market performance, the number of renters-turned-homeowners– a loss that had markedly affected the market– returned to a normal level. There just weren’t many renters left who both wanted to buy and met the scant financial qualifications recently required by lenders. Apartment occupancy climbed more than 3 percentage points in just a six-month period, reaching 90.5 percent by the middle of 2005. Rents, in turn, began to inch upward.
Only a trickle of new supply is on the way for 2006, which should help keep Houston’s occupancy rate at the heightened levels seen after Hurricane Katrina. As of mid-2005, properties under construction and scheduled for completion in Houston during 2006 totaled a modest 1,900 units. Projects with another 1,700 units were identifiable with approvals in place to start construction immediately. Improved occupancy certainly could trigger another surge in building starts. However, it might prove tougher than usual to get development geared up, since rebuilding efforts in Louisiana, Mississippi and Alabama likely will result in shortages of construction materials throughout the region.
The two neighborhoods that were really slammed during the just-completed phase of Houston’s apartment market cycle were Katy, a huge suburb on the metro’s west side, and the Champions area, which is the northwestern edge of the city of Houston. Shaping this struggle, these two submarkets combined to add half the new supply produced across the metro from 2003 through the middle of 2005. These two areas, furthermore, are key single-family home clusters for the metro, so they experienced sizable loss of renters to home purchases at the same time that apartment completions reached such startling levels.
The real bright spot in Houston’s apartment market over the past few years was the urban core, specifically the West Inner Loop area that extends westward from downtown inside Loop 610. This sector consistently maintained an occupancy premium of 4 to 5 percentage points over the metro norm, with the mid-2005 performance just under the essentially full mark at 94.5 percent. Helping sustain higher occupancy, completions were held to fairly reasonable levels, with deliveries totaling about 2,700 units from early 2003 through mid-2005. Most important, this is the one area of Houston where most renters choose their residences for lifestyle reasons. They want the vibrant environment found throughout the submarket, and they are willing to pay a sizable premium to get it. Rents in the West Inner Loop average $877 overall and close to $1,200 in properties built since 2000, topping the norm for all of Houston by about a third.
Condominiums play a minor role in the multifamily housing market for the West Inner Loop and the adjacent Galleria area (just west of Loop 610). Condo construction has increased mildly in these two submarkets, and a few top-of-the-market rental communities have been converted to luxury for-sale housing. Condos positioned as entry-level purchases are nearly non-existent anywhere in the metro, mainly because single-family home buying is such an affordable option for most Houston households.
Transactions Sizzle
Even before Hurricane Katrina pushed occupancy up in the Houston apartment market, sales activity was sky-high. The market ranked among the top picks for institutional buyers this year, since it took longer for performance trends from operations to reach bottom in Houston versus most other metros. Furthermore, because condo conversion is a viable option for only a sliver of Houston’s total multifamily stock, this is one of the few markets across the country where owner/operators aren’t guaranteed to get outbid by condo converters on nearly every deal that comes to the table. Transactions of sizable properties nearly doubled on a year-over-year basis during the first half of 2005, according to New York-based Real Capital Analytics. A total of 69 sales were closed in the January-June time frame.
Craig LaFollette, senior vice president for the CB Richard Ellis multifamily team in Houston, reports that his firm has another 28 assets, including a 16-property portfolio, that will sell by the end of 2005. ?For the first time in my 25-year career, the institutions have their timing right in Houston and are getting in just as the market performance is experiencing a huge upswing,” LaFollette says. ?This forward-looking strategy is how you make money in the cyclical Houston apartment market, and the institutional research departments have absolutely nailed the timing this round.”
Matthew Rotan, who heads the Houston office of Apartment Realty Advisors, reports that class A urban infill properties are the preferred asset among recent buyers, driving the prices for these deals to record levels. “The trading spread between classes is pretty narrow, and underwriting criteria are proving similar since there’s ample capital out there for every project that has come to market,” Rotan reports. “Past buyers of class B and C properties now are purchasing brand-new assets.”
With fundamentals looking so strong for Houston’s apartment market in 2006, recent buyers should achieve returns that exceed expectations set just a few months ago. It’s important to keep in mind, however, that this windfall comes at the expense of the industry’s valued customers, points out Terry Danner, who heads property management operations for Trammell Crow Residential in Houston. “Our apartments are full, but they’re full of unhappy people. We’ve got to make them feel at home.”