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Early Summer 2016 Commercial Real Estate Update

Investing in Commercial Real Estate for Stability

Present economic conditions are teetering on the edge of flat to very slow growth causing rising fears of a sustained slowdown. The catalysts of these issues are reductions in employment and investment in energy production and a general tapering of demand from overseas. The result to the United States as of June 2016 has been three months of below 200,000 hiring (only 38,000 in May), below 1% GDP growth (0.8% annualized in latest first quarter estimates), and flat growth of corporate profits. Not surprisingly, some investors are worried.

Charlotte - July Economic Update
Charlotte, NC

Those making the jump to say that slow economic growth equals a real estate downturn, or even the feared “bubble” should stop and take stock of the fundamentals. Occupancy rates for all major categories of commercial real estate, even apartments, are stable and improving nationwide. In fact, a recent Yardi Matrix report even states that the “worst” major metro it tracks is Houston, and its apartment occupancy rate is still 94.7% where energy price pains are the worst. Rents are generally still growing for all property types as well, even apartments. This point was also made clear by the same Yardi Matrix report stated that nationwide rents hit another all-time record high in May of $1,204 per month. If rents are rising and so are occupancies, then there is one simple conclusion; demand is still outpacing supply. That is a buying sign, not a selling sign, all else equal.

Supply Not Matching Increasing Demand

New supply, which has increased in the past few years, especially in the multifamily sector, may have trouble expanding in the future. Lenders appear increasingly stringent in providing development financing and labor and construction costs are not predicted to slow their perpetual increases. In fact, the internal, less discussed measures from the government jobs report show that hourly labor costs rose 3.9% in the first quarter. Thus, it appears that a part of the slowing pace of hiring is a cost constraint; not necessarily a falling demand issue. Developers of real estate have known this pain for years; they repeatedly tell stories of projects delayed and slowed due to labor shortages. For the commercial real estate market, this means that the supply and demand balance is likely to remain in favor of landlords, even if user demand cools moderately.

Those considering investing in real estate should look at these facts; solid fundamentals, low levels of new supply, and low interest rates when analyzing the next acquisition. Yes, it should be noted, that one great benefit of tepid economic indicators is remaining low interest and borrowing costs. The Federal Reserve is far less likely to push interest rate increases in 2016 than earlier thought and borrowers should take advantage of this. Plus, the real return to bonds and stocks is likely to drag lower compared to real estate, especially when considering the global exposure of many publicly traded companies. Real estate can provide a real income yield, supply and demand suggests that it can grow, and best yet, it can grow with inflation when and if it starts back up. Real estate offers income and stability in these types of economic climates; even REITs have outperformed the general stock market in 2016 to prove the point.

Investors Seeking Affordable Stability

Austin - Economic Update
Austin, TX

There is one theme that investors should keep mind, that is “affordability.” Rents can only rise as high as incomes (personal or business) can support. Growth patterns show people and firms moving from high-rent “24 hour” cities (New York, San Francisco, Los Angles for example) to lower rent “18 hour” cities (Nashville, Charlotte, Orlando, Phoenix, Austin for example). Thus, while the major markets have been the leaders in the past few years, it’s logical to expect the “secondary” markets to be the relative winners for the next several years. If a property provides great value and utility at a relative “affordable” price point; then it is best positioned to provide stability in all economic environments.

In conclusion, it would be a mistake to equate minor economic jitters with impending doom, as many on television like to do. The United States went through a significant downturn from 2008 through 2012, but frankly hasn’t grown that fast since. Thus, the economy really is not possibly “overheated” as it was last time. Since commercial real estate is undersupplied on a relative basis, it may actually be one of the best investment categories in the near to long term; a totally different starting point than in 2008.

To learn more about the current CRE market and economic conditions, read the SVN Commercial Real Estate Cooperation Report here.

[bctt tweet=”There is one theme that investors should keep mind, that is affordability #CRE” username=”svnic”]

Multifamily #CRE Focus on Houston/Harris County, Texas

More Expansion in All Sectors

The Houston, Texas apartment market is the fourth largest in the country with nearly 600,000 units. Looking at the real estate drivers, it’s easy see why there’s so much demand. More than 90,000 jobs were added in 2012. New construction of offices in the energy corridor, a new Exxon campus in Harris County, and new apartment construction throughout the Houston area has created a large employment demand that’s expected to be strong for at least the next two years. The Houston Consolidated Metropolitan Statistical Area (CMSA) has gained about 90,000 jobs per year since 2011 which creates a demand for 18,000 new apartment units per year.blog1

Average Class A cap rates have continued to decrease since mid-2010, from 7% to a low of 5.5% in 2012. During the same time average sales prices increased from $50,000 to $66,000/unit. Cap rates for 2013 are projected to stay about the same for Class A properties at about 5.4% to 5.6%. Values will tend to increase as much as 10% due to new demand from job growth and the lagging supply of new product which should cause rents to increase. Class B cap rates should range from 7.0% to 7.5% and Class Cs at 8% to 8.5%. Now is the time to sell before we go into “hypersupply” foreseen in about 18 months.

Vacancy Trend Shows 0.8% Improvement in 2012

Decreasing vacancy rates is one characteristic of the “expansion cycle.” Overall occupancy for all classes has improved 0.8% from year end 2011 to year end 2012. Based on the projected job growth for 2013, net occupancy should increase 1.0% in 2013. A projected 13,000+ units will come on the market in 2013.

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High Absorption/Low Construction

While the characteristic of  the expansion phase is high absorption, Houston saw an absorption in 2012 of about 12,250 units. The first half  of 2012 was a positive 7,141 units with a positive 5,112 units absorbed in the second half. This year, we should see an increase in absorption to as much as 16,000 units. Construction remained moderate in 2012 with 5,457 units constructed. Construction for the past 3 years (2010-2012) has averaged 5,222 units. In 2009 construction peaked at 19,330 units. Construction projections for 2013 anticipate as many as 13,000 units to be completed. At year end 2012 there were 12,785 units under construction and an additional 7,792 units proposed.

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Employment Growth

Our fourth characteristic in defining the expansion cycle is a market that shows moderate to high employment growth. As you can see from the Employment Growth chart, Houston has seen a large increase in employment growth in the last three years with last year increasing to 90,000 net new jobs after a negative 102.8 thousand lost in 2009. Basically, we have recovered the 2009 losses in the last three years. Jobs are projected to increase in 2013 to about 91,000. Historically Houston absorbs 1 new unit for every 5 new jobs.
About 16,000 units are expected to be absorbed in 2013. In 2012 there were 198 garden apartment sales in the Houston CMSA – up 13% from 2011. Projections for 2013 are 250 properties based on Houston’s peak years.

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Rental Rates and Rent Concessions…

As seen from the Rental Rate chart, in the last two years rental rates in the Houston area have increased about 9.4% or 4.7% per year.
Rental rates are expected to rise in 2013 for Class A & B apartments 4.7% above that of the 2012 levels. Rent concessions are almost non-existent except in the low end Class C & D properties.

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Top 6 Lenders of Garden Apartments in 2011-2012

 1. Holliday Fenoglio Fowler

880 units

$161,266,000  Total Volume

2. Wells Fargo Bank

2,207 units

$118,095,000 Total Volume

3. CBRE Multifamily Capital

1,832 units

$114,537,111 Total Volume

4. Jones Lang LaSalle

2,822 units

$105,663 Total Volume

5. Berkadia Commercial Mortgage

1,208 units

$84,100,000 Total Volume

6. Metropolitan Life Insurance

960 units

$72,090,000 Total Volume

Is it Time to Buy or Sell?

The best time to buy in Houston was the fourth quarter of 2010 to the 4th quarter of 2012 if you had money to rehab and could wait for the upside.  Well the upside is here and expected to continue in the Houston CMSA through 2017 based on job growth and a 3-year lull in new construction.  It is definitely a seller’s market and good properties are hard to find.  If you are looking for an increasing income in a dynamic market, it is time to buy or build.  As an owner it is time to think about selling in the next 12 months.

Prepared by:

Bill Forrest, Sperry Van Ness® Forrest Group
Bill Forrest, Sperry Van Ness® Forrest Group

Bill Forrest

MAI, Managing Director

Sperry Van Ness | W Forrest Group

Houston, Texas

*All Sperry Van Ness® offices are independently owned and operated.