A very pretty night in Austin, Texas.
Brandon Seidel A very pretty night in Austin, Texas.

The capital and fourth-largest city of Texas, Austin was the third fastest-growing city in the nation from 2000 to 2006 and has been known of late more readily for its rapid development than for anything else. The city’s official slogan as “The Live Music Capital of the World” has been recently upstaged by its unofficial slogan and campaign to “Keep Austin Weird,” referring to preserving both its progressive, eclectic lifestyle, and its base of smaller local businesses.

Although the building boom may begin to subside, Austin is anticipated to have one of the nation’s healthiest economies in 2009, spurring renter demand for apartments. While completions will be significant again this year, permitting activity peaked in the summer of 2008 and has declined steadily in recent months, pointing to a slowdown in building. This trend highlights a growing wariness among developers concerning potential oversupply and heightened difficulty in obtaining construction loans. Deliveries will put upward pressure on vacancy, especially during the first half of the year, but renter demand will remain healthy due to favorable demographic trends. The University of Texas, for instance, provides a steady renter base for local owners, and enrollment is expected to grow. During the last economic downturn, from 2001 to 2003, enrollment jumped nearly 7 percent with the addition of 3,200 students. Moreover, Austin has historically retained a significant portion of its college graduates, a trend that should continue as employment opportunities across the country remain limited.

Balance of Power

Steve Hollingsworth is an apartment investment sepcialist in the Austin office of Marcus & Millichap.
Steve Hollingsworth is an apartment investment sepcialist in the Austin office of Marcus & Millichap.

A still-growing local economy will help to maintain investor interest for Austin apartment properties in 2009. As institutions and REITs focus more on primary markets, some large, private buyers may be able to acquire assets with less competition from cash-heavy counterparts. Significant capital will remain a requirement, however, especially if cap rates stay in the current high-6 percent range. During the past several years, highly active out-of-state investors have pushed initial yields to the lowest level in the state, a trend that has begun to reverse as the balance of deals starts to favor local buyers. Listing activity also is primed to accelerate as out-of-state owners attempt to divest assets and raise capital to weather the downturns in their home markets. Some of these deals will be in the sought-after East and Near South Central areas, where students and workers that were priced out of the Central submarket continue to support demand.

Help Still Wanted

Early estimates indicate that employers added 3,100 positions in Austin during 2008, a modest 0.4 percent expansion of payrolls. Nonetheless, the market remained one of the few metros in the nation with positive job growth during the year, buoyed by overseas demand for technology products produced by local manufacturers. As the global economy struggles through a recession, however, many of the technology-related positions are projected to dissipate in the coming months. Dell, the metro’s largest private employer, announced the elimination of thousands of positions in early 2008.

Outside of the technology layoffs, Austin is in an advantageous position compared to the nation. The local housing market has remained more resilient than most markets across the country. As such, 2,100 jobs are projected to be added to payrolls during 2009, a 0.3 percent increase in employment.

Towering Inferno

Development was robust during 2008, as 6,000 units came online, representing a 4.1 percent increase to stock. Much of the construction is in emerging areas such as Cedar Park and South Austin as builders attempt to capture migration-related demand.

Despite an influx of job seekers moving to the metro in the coming months, the market is currently over-supplied, and absorption of new space in the suburbs is anticipated to take several months. In the city core, builders have been focusing on condo projects, including some high-profile towers. The 44-story 360 Tower, for example, came online in 2008 at 360 Nueces Street, featuring 430 units varying in price from $190,000 to $500,000. The 838,000-square-foot property was developed by Atlanta-based Novare Group and Andrews Urban, based in Austin. Also completed in 2008, the 23-floor The Shore condo tower boasts 192 units ranging from $200,000 to $1.4 million. Atlanta-based Trammell Crow Residential developed the $55 million project at 603 Davis Street.

During the past year, more than 4,000 condo units have been added to the Central submarket, in addition to several hundred conversions during the past four years. The resulting decrease in rental properties has left a dearth of housing for the large University of Texas student body. As a result, vacancy in adjacent submarkets has remained more stable as student renters sought out alternatives. In 2009, deliveries are projected to slow modestly to 5,700 units, a 3.8 percent expansion of stock. Nearly 1,000 for-sale units also are anticipated to be completed.

According to preliminary figures, vacancy finished 2008 at 7.9 percent, a 130 basis point rise from year-end 2007. Slowing job growth and still-robust development contributed to the rise. Class A vacancy has jumped 210 basis points to 9 percent during the past 12 months as a result of newly constructed properties competing with existing units and new condos employed as rentals. In the market’s lower tiers, however, vacancy has been more stable. During the past year, Class B/C vacancy has climbed just 20 basis points to 6.6 percent. In addition, many recent college graduates are choosing to remain in the renter pool due to tighter lending standards required to purchase a home. With job growth continuing to slow in 2009, vacancy is anticipated to rise 150 basis points to 9.4 percent.

Free Stuff

Due to the increase in vacancy, owners widened concessions in 2008 for the first time in four years. Asking rents during the year advanced 4.7 percent to $873 per month, while effective rents climbed 4.1 percent to $784 per month. Despite the jump in vacancy, healthy rent growth resulted in a 2.7 percent rise in metrowide average revenue during 2008.

In the metro’s top tier, asking rents improved 4.1 percent to $1,018 per month, as new developments pulled up the overall average. Class B/C owners, meanwhile, were proactive to combat potential occupancy declines, as asking rents increased only 3.3 percent to $714 per month. Average asking rents are projected to finish 2009 at $895 per month, while effective rents should advance to $794 per month, respective gains of 2.5 percent and1.3 percent.

A Fresh Outlook

Tighter credit markets and weakening fundamentals resulted in more measured activity during 2008, slowing transaction velocity 26 percent. Deal flow is projected to remain near current levels until credit begins to become more accessible. While still the highest in Texas, the median sales price retreated 8.6 percent to $62,400 per unit during the last year. Corresponding to slipping prices, average cap rates climbed 70 basis points to the high-6 percent range, including some deals closing above 7 percent near the end of the year.

Despite a major drop in sales activity from the peak, Austin apartment properties are trading and being financed, thanks largely to agency lenders and still-active local and regional commercial banks. The current apartment transaction climate, defined by various degrees of price declines, should be distinguished from the sector’s long-term intrinsic value. Properties that must be sold in today’s environment clearly require discounting to clear the market. On the other hand, owners without a compelling need for an immediate sale, the majority of whom report healthy operations, are positioned to hang on through the downturn.

More than ever, a fresh look at each property’s hold, refinance, or sell strategy is warranted, given the recent market volatility. There will be increased buying opportunities and distressed assets, more than any time in recent history, but investors should not generalize the overall condition of the apartment market as distressed.

Bradley Bailey, an investment specialist in the Austin office of Marcus & Millichap, contributed to this report.

Fast Facts:Austin, Texas
Population: 1.6 million
Occupancy: 92.1%
Median Age: 32.9
Median Household Income: $57,713
Average Rent: $873
Unemployment rate: 4.7%
NOTABLE: Originally settled in the 1830s as Waterloo, Austin, Texas, was named after Stephen F. Austin in 1839 who led the second—and the successful—colonization of the region by settlers from the United States. In 2006, Austin was selected as the No. 1 Best Big City by Money magazine and the No. 1 College Town by the Travel Channel. It has also been dubbed the greenest city and the fifth-safest city.

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