Houston is sitting pretty right about now. Thanks to growing employment trends, Texas’ most populous city is enjoying an economy well positioned for expansion this year and beyond. Not only will this happy state of affairs strengthen renter demand, it will also encourage new development. Metrowide, approximately 10,500 units are under construction and another 15,000 have been planned.

While new apartment supply in 2012 will more than double from 2011, deliveries should fall short of net absorption by a relatively wide margin, driving vacancy to its lowest level since 2006.

The Class A sector will receive the lion’s share of completions this year but also stands to see outsized demand growth as the education, health services, and energy-related industries create better-paying positions. This trend will extend well beyond 2012 as major energy firms, including Murphy’s Oil, Noble ­Energy, and ExxonMobil, relocate to the area or expand their local operations.

The Class B/C segment is also poised to tighten. Job creation in traditionally lower-paying industries, such as leisure/hospitality and construction, will drive demand for more affordable apartments, particularly in high-growth areas in the metro’s western half. Demand should rise substantially in Spring/Champions, which posts some of the highest vacancies in Houston, with construction-related payrolls rising as plans to expand West Loop North and Highway 290 progress.

Soaring Payrolls

Healthy economic growth is fueling apartment demand across the Houston MSA. Over the past year, employment growth in the Houston metro reached 3.6 percent with the addition of 93,000 jobs. This marks dramatic acceleration from the previous 12-month period, when local payrolls rose 2.3 percent. In the first half, payrolls in the trade, transportation, and utilities sector recorded the most significant growth, of approximately 15,000 jobs. Leisure and hospitality, and education and health services, followed, each adding 9,000 positions.

ExxonMobil, which is building a new campus in The Woodlands, recently announced plans to transfer 2,000 employees to Houston. The workers will move from Fairfax County, Va., where the company’s refining operations are currently headquartered. This in itself should also fuel job growth in the area as ancillary businesses look to be near ExxonMobil.

Sound Fundamentals

Year over year, overall apartment vacancy has fallen 210 basis points (bps), to 7.7 percent. The strongest improvements were recorded in higher-vacancy areas, such as the Heights, North Houston, and Spring/Champions submarkets. Class A vacancy declined 190 bps, to 6.2 percent, and Class B/C vacancy fell 220 bps, to 9 percent, the lowest level since early 2007. The Bellaire/West University, Montrose/River Oaks, and Sugar Land/Fort Bend County submarkets boast the tightest conditions, with Class B/C vacancy dropping below 5 ­percent.

Asking rents in Houston also showed improvement this year, rising 2.8 percent, to $795 per month, on a year-over-year basis, while effective rents advanced 3.4 percent, to $726 per month. Class A asking rents rose 2.8 percent, to $981 per month, while rents in the Class B/C sector grew 2.4 percent, to $633 per month.

Concessions average 4.5 weeks of free rent on a 12-month lease, down from more than five weeks of free rent two years ago. The most generous incentives can be found in the Katy/Bear Creek and Kingwood/Lake Houston submarkets, though below-average ­vacancy in both areas will prompt cutbacks.

In 2012, major private investors, REITs, and institutions targeted well-located Class A properties in the metro, driving cap rates down to the high–4 percent to mid–5 percent range. As best-of-class listings remain limited this year and cap rates hover near historically low levels, more investors will pursue Class B+ deals, which currently sell at cap rates in the 6 percent to 7 percent range and may see further compression as 2012 concludes. Assets in this segment, such as mid- to late-1990s and early-2000s product, not only offer more attractive first-year returns relative to top-tier properties, but may also command higher rents with limited cosmetic enhancements.

There are concerns that apartment sales may slow down as REO deals dwindle and for-sale inventory falls short of investor demand, particularly in the Class A segment of the market. In Houston, however, apartment sales should remain strong due to demand from investors looking to take advantage of attractive leveraged yields, NOI growth, and low capital gains.