Evacuees from New Orleans and nearby Gulf Coast cities poured into Texas after Hurricane Katrina struck on Aug. 29. Houston, located 350 miles west of New Orleans, suddenly no longer ruled as the country's apartment vacancy king. The negative impact of three years of overbuilding was erased virtually overnight.
Already well-positioned for an impressive comeback in 2006, Houston now looks like one of the country's stellar performers. Operators face plenty of challenges, however, as they will be called upon to help provide transitional services for traumatized new residents, some of them looking to start over and others hoping to return to their previous homes as quickly as possible.
Katrina's Impact
The number of displaced households welcomed into Texas after Hurricane Katrina proved staggering. An estimated 100,000 people were already staying in Lone Star State hotels at the time the hurricane hit, according to media reports. A week later, about a quarter-million people had registered for assistance at Texas emergency relief centers.
Houston's available better-quality apartments were snapped up immediately, mainly by employers leasing apartments to use as corporate housing once New Orleans-based operations could be relocated. Even while evacuations of people trapped at the Superdome and the New Orleans Convention Center were still in process, virtually no vacancies were left in the portfolios of key Houston apartment owners like Trammell Crow Residential and Camden Property Trust.
Many apartment owners in the area set up special programs for hurricane victims, agreeing to waive or reduce deposits, offer month-to-month leases, and take delayed payments from households waiting for financial assistance from the Federal Emergency Management Agency. Some companies relaxed the standards on household size, since there was such a shortage of big apartments capable of accommodating large families.
As of early September, Houston still had about 27,000 evacuees staying at emergency shelters. Plans called for placing those households in other locations by the end of the month. It appeared some would be able to go back to Louisiana, where trailer and tent camps were being considered. Others were targeted for placement in Houston apartments, though that process was expected to be a challenge since the Harris County Housing Authority reported that nearly all of the evacuees remaining in local shelters qualified for Section 8 subsidized housing.
Building is Winding Down
With so few barriers to entry, no market can crank out additional product quite the way Houston can, and the metro area is just finishing another one of its notorious building booms. From the beginning of 2003 through the middle of 2005, roughly 28,800 new apartments were delivered. Another 5,500 units under construction as of mid-2005 were scheduled for completion by the end of the year, bringing the three-year delivery tally to more than 34,000 units.
Timing couldn't have been much worse when this product began to come on stream in early 2003, as the jump in new supply hit just as the metro was hemorrhaging renters to single-family home purchases. With the metro's median home price at only $135,500, according to the National Association of Realtors, the rush to purchase when mortgage interest rates dropped became a real stampede. According to Dallas-based M/PF YieldStar's quarterly survey, apartment occupancy bottomed at just below 87 percent, lowest in the country, during late 2004. Surprisingly, however, rent cuts during the occupancy slide proved small. Operators smartly realized that cheaper rents wouldn't stem the flow of residents leaving through the back door to make home purchases.
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."
Looking Good
Apartment statistics show marked improvement. Multifamily occupancy levels increased in the first half of 2005, thanks to low completion levels and substantial conversion activity, according to research firm Marcus & Millichap. That boost has been the key driver of the improvement recorded in the accompanying revenue index, a figure that is calculated by multiplying occupancy by the average inflation-adjusted effective rent.
Other findings in this quarter's analysis:
- After bottoming at 89 percent in late 2002, the revenue index improved to 93 percent of 2000 levels in the first half of 2005.
- The second quarter of 2005 marked the sixth quarterly gain in a row in the revenue index.
- Occupancy gains were the top source of improvement in the index. The national occupancy rate rose to 93.6 percent in the second quarter of 2005.
- Conversion sales continued to accelerate during the quarter. More than 68,000 units have sold for conversion this year– nearly three times the 23,000 units sold during the same period last year.
- Sustained job growth has supported increased demand. As of July, more than 1.3 million jobs have been created this year, a number comparable to the rate of growth during the same period in 2004.
- Modest effective rent growth of 1.1 percent was recorded during the first half of this year. The average effective rent is currently $886 per month.
- Apartment completions have slowed so far this year, as indicated by the completions index. In the second quarter of 2005, completions as a percent of inventory were only 40 percent of the 2000 average.
Upward Trend
The first MFE Index shows markets' recovery.
The MFE Index, published quarterly, reviews the national apartment market performance and analyzes its fundamentals in partnership with Marcus & Millichap, an Atlanta-based brokerage firm. The indeces, such as the revenue index and the completions index, are indexed to the last cyclical peak (year 2000 = 100) to provide insight as to where current fundamentals stand in relationship to the height of the market.
To date in 2005, the recovery is gaining traction as the combination of inventory reduction from condo conversions and stronger leasing activity support improving occupancy. As a result, effective rents are rising as concessions burn. Marcus & Millichap expects occupancy to rise to 94 percent by year end, and effective rents will post a 2-plus percent gain for the year. Barring a major shock, there are no signs that the recovery will stall in 2006. These factors underpin the firm's current expectation that, on a national basis, the apartment market will be nearing equilibrium going into 2007.