If Houston’s employment growth pace over the near term slows to somewhere near half the level recorded of late, underlying support for housing demand, including apartment absorption, should erode. Substantial completion volumes that lie just ahead also are of concern in this metro’s outlook.
What’s the Current Performance?
In part one and two, we discussed some of the changes to Houston’s energy sector. Important to realize, Houston’s apartment market is entering this period of vulnerability when conditions are unusually strong. There’s room to lose some of its momentum and still log very solid results.
MPF Research’s early stats for Q4 2014 show occupancy at 93.8%. That reading is down from 94.5% as of Q3, but the dip seen over the past few months is a routine seasonal shift. The seasonal occupancy peak recorded in Q3 was, in fact, a 13-year high that reached more than 200 basis points over the average posted during the past couple of decades. (A big block of obsolete product in largely undesirable neighborhoods perpetually holds Houston’s overall occupancy figure under the U.S. norm: An average level around 94% truly is the best reading this metro ever gets.)
Strong pricing power is an even more pronounced indicator of the momentum that has been present in Houston’s apartment market of late. During Q4, when there’s a seasonal tendency for rents to hold basically flat, effective rates for new leases bumped up 0.7%. The quarterly climb pushed total rent growth in calendar 2014 to 5.2%. Annual rent growth is really, really robust at 6.9% in the metro’s large stock of class B product. But other product sectors are doing quite well, too, with rent up just a hair under 4% year-over-year in both the class A and class C property categories.
How Big Is the Wave of Near-Term Deliveries?
During the past few months, Houston moved ahead of Dallas/Fort Worth and Washington, DC to rank as the nation’s most active apartment building center. Going into 2015, properties that total 33,586 units are under construction. Within that group, 23,420 units are in developments that are scheduled to finish during 2015, so the coming year’s deliveries should nearly double the 12,046 units brought to market during 2014. Encouragingly, the completions dates targeted for 2015’s deliveries are heavy during the prime leasing periods of Q2 and Q3, versus somewhat more moderate deliveries targeted in the weaker leasing periods of Q1 and Q4.
Digging into the near-term supply numbers by product price point and neighborhood lends further insight into what may be on the way for Houston’s apartment market performance. A whopping 39% of 2015’s scheduled deliveries are in particularly expensive neighborhoods where the average monthly rents for new apartments tend to run at about $1,800 to $2,000. These areas are the Downtown/West Inner Loop, Greenway Plaza/Upper Kirby, Galleria/Uptown and Memorial submarkets. Another 10% of the coming year’s targeted deliveries are found in the Medical Center/University and Westchase submarkets, where pricing for new units tends to average $1,300 to $1,500 monthly. The remaining 51% of Houston’s completions will be in suburban locales with average rents for new units at approximately $1,000 to $1,200 per month. The suburban units in 2015’s scheduled completion block are distributed across a wide range of neighborhoods, though inventory growth rates will be fairly aggressive in four submarkets: the Rosenberg/Richmond, Spring/Tomball, The Woodlands and Katy neighborhoods.
With energy-influenced jobs comprising such a large portion of Houston’s total job base, probably no individual area can completely sidestep some impact from a downturn in the oil business. However, a handful of the submarkets with significant apartment construction in process do appear comparatively less vulnerable because of somewhat limited energy job exposure. These more promising submarkets include the Medical Center/University district as well as the Fort Bend County submarkets found on the metro’s south side, including the Rosenberg/Richmond area.
What’s the Magnitude of the Anticipated Slowdown?
Reflecting lots of product availability, Houston apartment demand during 2015 should come in at a level somewhat stronger than anticipated employment growth near 60,000 jobs would suggest. New units coming on stream won’t just sit empty, as operators will do what they need to do on pricing in order to keep those additions moving through the lease-up process. MPF Research is anticipating demand for some 15,500 to 17,100 units. (All forecast performance stats presented here for Houston’s apartment market are preliminary figures. Slightly finetuned figures will be available in early January.)
At the end of 2015, then, occupancy near 92.9% is anticipated in Houston’s apartment sector, dropping 90 basis points from late 2014’s performance.
Annual rent growth is forecast at roughly 2.9%, slowing meaningfully from the 5.2% increase realized in 2014. This overall rent growth outlook takes into consideration hefty variation, by both product niche and neighborhood.
• In class A communities look for overall rent growth just a little under 1%. Keeping rent change in positive territory for this product niche, healthy pricing power is anticipated for top-tier product in the suburbs. Given new supply has been limited to date in the suburbs during this cycle, these neighborhoods actually look starved for additions, so 2015’s completions should lease well in most spots while still allowing existing better-quality properties to push rents. In contrast, price cuts are anticipated within Houston’s urban core class A product category. The sizable deliveries already seen to date in these neighborhoods don’t appear to leave real pent-up demand, so another big round of completions at the same time job growth slows could lead to leasing challenges.
• In class B communities, rent growth around the 4% mark appears achievable, while pricing increases around 3% are forecast in the class C product space. These are healthy numbers, but they do slow from 2014’s performances, mainly easing to levels more similar to anticipated wage growth.
What is on the Horizon for Houston in 2015?
Rough revenue growth for Houston apartments in 2015 is anticipated around 2%, reflecting rent increases near 2.9%, but a drop in occupancy of roughly 90 basis points. That’s certainly a sizable shift from revenue growth that topped 5% during the past year, and it ranks as the biggest slowdown foreseen among the country’s major apartment markets. Still, it’s encouraging to some degree that Houston appears able to take such a big hit to the metro’s most significant economic driver and still achieve apartment revenue change that remains in positive territory.
Having said that, realize that there is downside risk that the apartment sector’s performance could deteriorate more meaningfully than this base-case scenario outlines. If oil prices were to falter to below $40 to $50 per barrel and hold at that weakened level for some time, almost all of the country’s oil production from wells that utilize the hydraulic fracturing drilling technique would turn unprofitable. In that situation, the question becomes how drastic Houston’s job losses would be, rather than how much the net growth pace slows. In turn, apartment revenue change could spiral downward very quickly.