An enormous market-friendly mismatch between demand and supply since 2010, supported by the robust economic performance, has altered the profile of the local apartment market nearly as much as did Hurricane Katrina with is massive inflow of residents several years earlier. The mismatch, the declining vacancy rates that attended it and the strong rent growth it generated, set the stage for the intensification of construction now underway. Still, development will not run rampant as it did in some past building cycles; an overall air of prudence should keep the market from oversupply. Indeed, the market, riding on the backs of the strong energy and health care sectors, should continue to tighten, if more slowly, in the period ahead. Rent growth should remain formidable.
Never a dull moment. Market-rate apartment occupancy has been on a roller coaster ride for the last several years. The unanticipated extraordinary demand arising from the Hurricane Katrina in-migration flood saved the market from double-digit vacancy rates with a decisive decline. The recession that followed drove the rate back to the double-digits, indeed to even higher rates. The rallying of demand that followed in 2010 in combination with a cutback in development initiated yet another rapid descent. By the end of second quarter 2012 the vacancy rate had declined to 7.6%, down fully 50 basis points from the quarter before, down 220 year-over-year. The onset of a new cycle of development, however, should bring these precipitous declines to an end—but not before the rate sheds 60 additional basis points over the remainder of the year. Another up-cycle in the rate, however, is not expected this time around. Relative stability in the neighborhood of 7.0%, rather, is expected for an extended period post-2012.
While demand has been particularly strong for Class A units in popular areas (mainly Houston’s west side), and Class A vacancy is notably lower than Class B/C, both rates have been declining, an effect of the economic recovery’s embrace of both high-and lower-paying industry sectors. Class A vacancy ended second quarter at 6.1%, down 200 basis points year-over-year. At 9.0%, the quarter-end “B/C” rate was down 220 points over the same time span. The Class A descent, however, occurred even as 1,425 new units completed construction over the past four quarters; no Class B/C units delivered over that span.
SUPPLY AND DEMAND
Strong demand riding on the back of a strong economic recovery and augmented by well-known trends in the single-family market led to 27,388 units of positive market-rate net absorption over the two-year span 2010-2011. 4,881 units of net absorption followed during the first half of 2012 (including second quarter’s 2,803). Meanwhile, a dramatic slowdown in construction completions, the result of the earlier recession-driven reduction in starts occurred alongside the rising tide of demand. The 1,986 market-rate apartments that delivered in 2011 amounted to the smallest single-year completion total since 1991. Within submarket boundaries only two projects with a combined total of 640 units followed during the first half of 2012, a fraction of the period’s net absorption total and the occasion for additional tightening, as described.
With this as background, the market sits on the brink of a new cycle as recent hefty increases in construction, no surprise given economic and market trends, begins to bear fruit. Indeed, Reis’ early August report on individual construction projects reports 10,671 market-rate units under construction in 35 projects metrowide. Including a 172-unit property that delivered in March in southeast suburban Pearland, just beyond submarket boundaries, the market-rate delivery total for 2012 will be 3,193 units. With completion totals rising and starts continuing, however,
the sum for 2013 is projected at 6,534 units, 4,501 of which were underway in 15 properties per report date. While these are large sums representing a substantial revival of development, they are not great alongside what market has produced in other building cycles.
Reis expects a ready response on the part of demand; this time around the market should avoid oversupply. Indeed, even with demand slowing as, possibly, demand for single-family homes increases, 2013 net absorption is projected at more than 7,000 units. The total for 2012, meanwhile, is projected at more than 10,800. “We will see increased supply in the next 18 months, but we will be lucky to build enough product to meet demand during that time,” summarized an executive from developer Wood Partners is an article prepared for the July issue of Texas Real Estate Business (TREB). “With average Class A vacancies below 7% and rents spiking,” observes Cushman & Wakefield, “developers have been hustling to be first in line to bring new multifamily product out of the ground and to the Houston inner loop market.”
“Development capital,” continues the Wood Partners executive, “is available for quality infill sites, but investors are still being appropriately careful with their choice of sites and sponsors, which we believe will foster a long, healthy development cycle here… The most recent trend we are seeing is that investor focus may shift to suburban development by the end of this year… Strong rent growth is occurring in most of Houston’s submarkets now, which opens the door to new development in other areas.” (See the Submarkets section of this Reis Observer for more on the spread of development. See Special Real Estate Factors for commentary on demand by property class.)
The strong demand of the past couple of years has ushered in the return of positive rent growth. Indeed, the period of loss, confined essentially to 2009, was as brief as were the losses small (all losses had been redeemed by early 2010). At $820 and $766 per month, asking and effective averages for second quarter 2012 were up fully 1.2% and 1.4% for the quarter and were up 2.1% and 2.7% since year-end in the wake of respective gains of 2.1% and 2.3% in 2011 all told. Rates of growth, accordingly, have roughly doubled this year compared with last. The current forecast, accordingly, calls for increases on the order of 4.4% and 5.6% for the year as a whole.
Reflecting the broad base of demand that has spread across all tiers of the market, growth in average asking rents, which earlier had favored Class A, now includes Class B/C as well. At $1,012 and $654, second quarter mean asking rates for Class A and B/C apartments were up 1.1% and 1.2% from the quarter preceding and were up 2.1% and 1.9% since year-end—precisely the increases reported for all of 2011. “[T]ightening occupancy and low supply are driving concessions out of both urban and suburban markets,” according to the above cited July report by Wood Partners/TREB. “As for leasing activity, given how much demand there is for Class A apartments right now, most owners seem to be focusing on delivering a better leasing and living experience via thoughtful design of common area spaces and amenity programming, rather than offering substantial rental concessions.”