A Wild Ride – The market has been a roller coaster ride straight up. What’s on the tracks ahead?

By BRUCE MCCLENNY, ApartmentData.com

The Market Ride

The Houston Apartment Market continues to advance from its lofty perch achieved in 2021. After finishing 2021 with historic rent growth of 13.9% driven by an all-time high absorption performance of 38,000 units, Houston keeps moving these metrics higher. At the end of 2021, overall average rent reached $1,188 per month. The rent level over the first four months has continually improved by $32 to a new height of $1,220 per month. This movement represents a 2.7% nominal increase or 8.1% when annualized.

Overall occupancy ended 2021 at 91.5%, a pinnacle that was surpassed at the end of April when occupancy rose 20 basis points to establish a new high at 91.7%.

The graph on Page 36 illustrates how the recent historic highs of occupancy and rent was formed from a 12-year perspective. The graph starts in 2010 as the market was emerging from the Great Recession, back when rent was a mere $730 per month and occupancy was a meager 86.0%. Since then, occupancy resembles a roller coaster ride with a slow ascent to its first peak of 91.4% in 2015 during the Fracking Boom. Then in 2016, the Fracking Bust put occupancy in a free-fall, dropping it to 88.3%. The next hill looks like a bunny hop with occupancy reaching 90.0% mid-year 2019. 2020’s COVID-19 outbreak, with its economic lockdown, was similar to a descending barrel roll, moving occupancy to a valley of 88.4 percent. As the market gained speed banking into 2021, the reopening economy catapulted occupancy and rent to their historic lofty positions.

At the current stage of the market’s ride, we are at a blind-spot, unable to see what’s over this peak. Is it another descent or a straight- away? There is a tremendous amount of uncertainty on the tracks with war, inflation and the prospect of recession or stagflation raging.

Riding by Class

The overall statistics of rent and occupancy are an aggregation of the performance of each class of property. Classes are determined by a bell curve distribution of market rates or price. The top table on Page 37 shows how each Class differs in performance and how each contributes to the overall market statistics as of April 30, 2022. In addition, Class A has been divided into two groups. One group is the Class A properties that began leasing in 2021 and 2022. Since properties in this group are in varying degrees of lease-up, occupancy is understandably low at 41.9%. Due to the ever-increasing supply of this group during the time frame analyzed, rent trends cannot be properly calculated. Filtering out the lease-up properties of 2021 and 2022 from Class A creates the Class A Stable group.

All classes are exhibiting elements of outstanding performance. When the overall statistics represent historical highs for occupancy and rent, it’s natural for those fundamentals to shine throughout the class distribution. As for rent trend and absorption, those metrics, while still significant, are moderating from their highs as of the end of 2021, when rent growth registered 13.9% and absorption soared to 38,046 units.

The 4-month rent trend is annualized to provide an approximation of what rent growth might be if the current trend is maintained. An 8.1% rent growth for 2022 would be an outstanding accomplishment. Among all the very positive numbers on the classification table, one statistic really stands out, the 4-month negative absorption performance of Class B. This number, -1,231 units, suggests that more are moving out than moving into Class B units. Could this mean that high prices are driving residents out of Class B to the lower price alternatives of Class C and D, or into shadow rentals? Or, as one broker supposes, the negative absorption is a result of rehab activity that keeps a unit vacant? Stay tuned as this negative trend grows or fades to be no more than a “tempest in a teapot.”

The Top 10 Submarkets

The economic reopening in 2021 generated 159,700 jobs, which ignited a historic amount of absorption. In the apartment industry, absorption is an expression of demand which indicates the change in the number of occupied units. The table at bottom right lists the top 10 submarkets based on absorption over the last 12 months. In addition, the table shows recently opened new supply and rent growth.

The post pandemic market has created an economic situation where demand exceeds supply across many industries, which has spiked prices. The current inflation rate, as measured by the Consumer Price Index, is 8.54%, the highest since December 1981. The news is full of examples of prices spiraling higher, such as automobiles, food, energy and housing.

Over the past 12 months, the Houston metro area generated 31,456 units of positive absorption, which far surpassed the 19,931 units of new supply delivered over the same time frame. With such an enormous imbalance in supply and demand, monthly average prices soared by 11.7%. The table at right shows only the absorption performance of the top 10 submarkets. Katy and The Heights are perennial leaders in absorption and construction. The suburban markets of Tomball and Lake Houston, as well as the core markets of Montrose and Highland Village, consistently deliver good absorption numbers and are no surprise making this list. However, the markets of Alief, Willowbrook/Champions, Memorial and Brookhollow are somewhat of a surprise. But, after more consideration, their presence on the top 10 list makes sense during these times, as renters are likely to be moving to more affordable markets as rent levels move higher.

This table also provides insight into considering how 2022 might unfold by focusing on what’s presently under construction and the 6month annualized rent trend. Of the 14,799 units under construction, assume that 11,000 units will deliver this year. Then add the 4,000 units already delivered, which results in approximately 15,000 units delivered by year’s end. This number of deliveries is considerably less than the 19,000 units delivered in 2021 and the 22,000 units delivered in 2022. Apartment supply and the development pipeline has been constrained by the time lost by developers during the 2020 lockdown and then thrown off schedule with labor shortages and materials availability.

As for demand, look to the Greater Houston Partnership’s 2022 forecast of 75,000 jobs which equates to a 2.5% increase in employment. Also consider, the Federal Reserve Bank of Dallas has issued a job forecast for Texas which expects the state’s employment to increase by 2.9% in 2022. If this growth rate of 2.9% is applied to Houston, job growth would register around 91,000 new jobs. Let’s assume that Houston’s job growth for 2022 will range between these two forecasts, 75,000 to 91,000. Using a 5-to-1 conversion ratio, absorption will be 15,000 to 18,200 units. This absorption narrative covers new supply and keeps occupancy high and growing from its current level of 91.7%.

Using the annualized 6-month rent growth of 7.5% as a proxy for 2022 assumes that the next six months will continue at the same pace as the last six months. This scenario might be too aggressive to realize for 2022. Yet, the absorption versus the supply dynamics described above support strong rent growth. In September 2021, I forecast 5.0% rent growth for 2022. Plus, consider all the economic uncertainty that exists with the possibility of recession looming as a drag on current conditions. In any event, rent growth for 2022 should be well above the long term average and in the range of 5.0% to 7.0%.

The wild ride continues.

Bruce McClenny is president of ApartmentData.com. For more details, call 281-759-2200, email bruce@apartmentdata.com, see Marketline on Page 75 and subscribe to his YouTube channel at: https://www.youtube.com/channel/UCaPmY9AevdjCpqe4UeQU7xw/featured