Multifamily goes from darling to distress in Texas

Imbalanced pipelines, price dips point to trouble in major markets.

For the past few years, Texas multifamily was one of the hottest real estate investments in the country. 

Not anymore. 

Industry players think the trouble has only just begun, and that might be a lagging assessment. Plenty of properties already are being sold at major discounts, and once-mighty development pipelines are all but dead is some cities. 

No segment of the asset class is safe. A deluge of Class A apartments will come online in the next 18 months, giving developers little power over pricing. At the same time, they will need to scramble to fill apartments so they can refinance their construction loans or sell before they mature.

Meanwhile, many of the Class B and Class C value-add properties that were bought for record prices in 2021 and 2022 have seen major declines in values. Heightened renovation costs and falling rents have complicated value-add plays, all while owners are being forced to replace expiring rate caps and refinance into more expensive debt. 

There will be winners, particularly those with enough cash to weather the short-term. But there will also be losers: scores of small developers, syndicators and Main Street investors are now staring down a massacre in the Lone Star state. 

Pipeline problems

The picture in Texas multifamily has changed so severely that the recent past sounds like a totally different era. 

During the pandemic, Texas’ major metros built up some of the biggest development pipelines in the country. 

In Dallas-Fort Worth, the most populous of the Texas Triangle metros, about 63,350 units are in the pipeline right now, according to a recent report from commercial real estate firm Partners. For each of the three previous three years, that number has been closer to 49,000. This year, 23,662 units have already been delivered, double the 11,707 units delivered at this point last year. 

Deliveries have tripled in San Antonio and increased by 76 percent in Austin. New apartments are still being absorbed at a steady clip, but occupancy has ticked down to below 90 percent in Austin and San Antonio. 

Steve Triolet, a research and market forecasting expert at Partners, considers a 10 percent vacancy rate to be the breaking point where tenants gain the upper hand in a market. 

“They built so much in such a short time window,” Triolet said. “All the Texas markets now are in between neutral and tenant-favorable conditions, where a year and a half ago, all were landlord favorable.”

Landlords are in a vise — on one end, they’ve lost pricing power due to the enormous amount of similar, newly built projects flooding the market. On the other, many of the construction loans that funded their developments are maturing. Developers can either sell their projects or refinance them, but in many cases, neither option is an easy one. 

Even as the Fed has paused rate increases for now, the cost of debt is still far higher than it was when developers underwrote their projects. That would make selling more attractive, but in order to sell, an owner needs heads in beds. 

Typically, a developer looking to sell might offer a couple months free on the front-end of the lease to achieve higher rents on paper, and then sell based on those rents. But now, developers are dropping rents to expand their pool of potential renters. 

“Anyone who has to sell something in the next six to 12 months understands that they’re probably not hitting their projections on exit price,” said J.R. Ellis, an investment sales executive at Greysteel, a real estate advisory firm. 

Assumable debt, which has helped make deals pencil out over the past year in cooler markets to the north, is now in vogue in Texas, too. Ellis recently arranged the sale of Park at Rialto, a 274-unit project at 25051 Interstate 10 West in San Antonio. GenCap Partners developed Park at Rialto in 2017, and passed its $28.1 million, fixed-rate Fannie Mae loan along to the buyer when it sold in October. The loan’s interest rate is below 4 percent, handily beating the current secured overnight financing rate of 5.32 percent. 

If the near-end of the pipeline is bursting at the seams with deliveries, the far end is barely even active. 

“Urban development is so far off from penciling,” Ellis said. “We haven’t seen many starts, and the general sentiment from developers who have a strong presence in Austin is the pipeline is scary.”