Houston—Legacy Partners just placed a big bet on Houston. This September, workers will start digging the foundation for Legacy at Memorial, a new 25-story high-rise overlooking Buffalo Bayou, the long park that lines Memorial Drive on its way downtown.

Although it’s Legacy’s first development in Houston, the apartment developer, based in Foster City, Calif., plans to double down. It is committed to building a portfolio of apartment properties here, said Spencer Stuart, a senior vice president and partner at the firm.

That’s something developers can accomplish much more easily here than elsewhere. With no official zoning requirements, Houston may have the lowest barriers to development of any big city in the country. “At any point of the compass you turn, people are building,” Stuart said.

Fortunately, a strong economy is helping Houston fill both the new apartments and soak up some of the empty apartments left over from the downturn, even as evacuees from New Orleans gradually leave this southeastern Texas city.

Houston absorbs new units

Developers will open 7,000 new apartments in Houston in 2007, increasing the existing inventory of 443,672 by 1.5 percent, according to Reis, Inc., a real estate research firm.

Even with all that new supply coming on-line, absorption rates are strong enough to allow the city to fill those new apartments without raising the vacancy rate, which is expected to end the year at 7.1 percent, unchanged from its level at the end of 2006.

Although that vacancy rate is too high to be healthy, it’s a significant improvement from early 2005, when it was approaching 11 percent, according to Reis.

One phenomenon that helped improve business was the series of hurricanes that hit the Gulf Coast in 2005, which brought in a flood of evacuees from New Orleans, including 36,000 households that received rental subsidy from the Federal Emergency Management Agency or the Department of Housing and Urban Development.

By the end of 2005, the vacancy rate had fallen to 6.2 percent.

And now that two-thirds of the displaced are no longer receiving housing subsidies—meaning they’ve either left Houston or have settled in for a while—property owners don’t have to worry about whether they’re all going to leave en masse and drive up the vacancy rate, analysts said.

In any case, a rising population and healthy job growth is keeping the market strong. Houston added about 80,000 new jobs in 2005, as the Katrina victims came to the city, and another 60,000 last year, even as some of those evacuees left. The net effect has been a lasting improvement to the market, while the temporary benefits of an extra population came and went.

“The Katrina effect masked how well the apartment market did,” said Bruce McClenny, a researcher for Apartment Data Services, a local research firm. His company puts the vacancy rate higher than Reis, at about 12 percent, but notes the same fundamental strengthening of Houston’s apartment market over the last two years.

Vacancies likely would shrink even more if developers weren’t building like crazy. Between 4,000 and 5,000 apartments will open each year between 2008 and 2011, according to Reis.

About 15,000 new market-rate apartments are now under construction, with about half in the suburbs northeast and southwest of the city. More than 4,000 units are being built in the middle of the metro area, inside the loop of Interstate 610 or close to it, and another 5,000 are in the pipeline, according to a list of new developments kept by Apartment Data Services.

“The best location in Houston is the West Inner Loop, from downtown to the Galleria, the Medical Center through the Museum District,” said Stuart of Legacy Partners. “It has the highest absorption and the highest rents.”

To protect itself, the company has picked a site that other developers can’t get close to. Legacy at Memorial is nestled in a U of parkland, overlooking the parkway with Spotts Park a few blocks to the west and Glenwood Cemetery immediately to the east. The location has an easy 15-minute commute to downtown Houston by car.

Legacy’s luxury apartments will earn average monthly rents of $2,393, or more than $2 per square foot—well above the average of just $663 per month, or 77 cents per square foot, according to Apartment Data Services. Houston’s rents should keep rising by roughly 3 percent a year through 2011, according to Reis.

Sales prices stabilize in Houston

It will cost Legacy more than $60 million to build the 334 apartments overlooking Memorial Drive, using a construction loan from Capmark and equity provided by California Public Employees’ Retirement System. That works out to more than $180,000 per apartment.

That’s a little higher than the average purchase price of about $166,000 per apartment for a high-rise or mid-rise property in Houston in 2006, according to Real Capital Analytics, a research company based in New York City. It’s also much, much higher than the roughly $71,000 per unit cost of garden apartment properties. Investors bought and sold $2.4 billion in apartment properties in Houston in 2006.

Because only 2 percent of the buyers were condominium converters in 2006, Houston’s capitalization rates were higher than in the rest of the country. Cap rates represent the income for a property as a percentage of the sales price. The average cap rate in Houston was 7.3 percent in 2006, compared to, for example, 5.7 percent in Phoenix or 6.4 percent in Austin.