Michael Becker's Q4 2024 "State of the Market"
Q4'24 State of the Market: "2025 Texas Multifamily Market Outlook"
Written by SPI Co-Founder & Principal, Michael Becker
Q4 2024 Newsletter
Hi, Michael Becker Here...
In this newsletter, I will discuss what I foresee for Texas multifamily in 2025. I will also refer to several charts from CBRE's 2025 US Real Estate Market Outlook report to further illustrate my points.
We All Have Survived 'til 2025
For the last two years, since I first heard James Eng from Old Capital coin the phrase "Survive 'til '25" (a rendition of the old Sam Zell quote from the S&L crisis of the 80s & 90s – "Survive 'til '95"), it’s become commonplace in the multifamily industry. 2025 is just days away as I write this article, and to me, it’s a very welcomed turning of the calendar. To be clear, I don’t expect it to be a "magic pill" that solves all multifamily-related issues when the calendar flips to January 1st, 2025, but I’m optimistic that we will look back with the benefit of hindsight and see that it was a milestone in sentiment shift. Let me expand upon that below…
2025 Multifamily Sales Activity Should Increase
In several market forecasts I have read (including the CBRE Outlook report referenced above), multifamily is projected to be the most preferred asset class for commercial real estate investors in 2025. While short-term negative effects were brought on by record levels of new supply and the Fed’s most aggressive hiking cycle in decades, as time progresses, strong renter demand will drive improving occupancy and accelerating rent growth, leading to increased multifamily investment activity in 2025.
As I have talked about in prior newsletters, 2023 and 2024 multifamily investment sales activity was well below the stratospheric levels seen in 2021 and 2022. Additionally, in certain markets like Austin, transaction activity is still dramatically below pre-COVID levels.
For example, I recently spoke with one of the largest multifamily brokers in Austin, and he noted, in a very somber tone, that between 2014 and 2019, Austin averaged around 100 property sales a year in the 100+ unit space. In this same 100+ unit category of the Austin MSA, there were 35 sales in 2023, and for 2024 he expects the number of sales to be around 30.
In addition to seeing just 30-35% of the average sales from pre-COVID "normal times" in 2023 and 2024, the recent, major expansion in the number of market-rate Austin multifamily units means that the Austin market is now nearly double the size it was in 2014. Once you factor in this large expansion in multifamily stock, sales activity is likely closer to 15-20% of where it otherwise would have been.
In summation, I believe Texas multifamily sales activity has nowhere to go but up. It seems very probable to me that 2024 will mark a low point in transactions, and 2025 will see quite a bit more activity. I am sure all the sales brokers, lenders, and other service providers reading this article would be pleased to see my prediction come to fruition.
Post-Peak Multifamily Supply
I noted in the Q3 2024 issue of our newsletter that I believe that the current window represents a "Generational Buying Opportunity." My call is in large part based on what is expected to be a much more favorable new delivery landscape for many years to come.
To elaborate on this same point from the last newsletter in a different way, the chart from the CBRE research department above discusses 16 of the highest new multifamily supply markets. It forecasts when these markets hit or will hit their peak supply of deliveries, and when CBRE expects rental rate growth to return. As you can see, CBRE reports Austin, Dallas, and Fort Worth are all post-peak supply, and San Antonio is projected to peak in Q1 2025.
This all generally aligns with my forecast from the past 12+ months that, around Q2 2025, the market will feel a meaninful shift in multifamily fundamentals (i.e., rent growth and higher occupancy). This shift should first appear in North Texas (DFW) and follow a bit later in Central Texas (Austin/San Antonio), due to the higher percentage of new supply delivered by Central Texas compared to North Texas.
Cost-to-Buy Premium Will Continue to Favor Rental Market
Also noted in the same report by the CBRE research department, the cost-to-buy premium should continue to favor the rental market for years to come. CBRE noted that “With average newly originated mortgage payments 35% higher than average apartment rents as of Q3 2024, many U.S. households continue to rent rather than buy a home. Even though the premium to buy a home is expected to come down over the next several years based on home-price, interest-rate and rent growth forecasts, it will remain high enough to keep today’s renters renting for longer.”
“All markets will see their cost-to-buy premiums shrink over the next five years as interest rates fall, home price growth remains subdued and rent growth accelerates. Austin and Los Angeles have the highest cost-to-buy premiums in the country, both more than 2.5 times the average rent. Although that premium will come down over the next five years, it will remain more than twice as expensive to buy than to rent.”
My takeaway from all of this is that while mortgage rates are expected to eventually fall and multifamily rents are expected to rise over the coming years, the affordability gap will narrow. However, it still seems likely that, for the foreseeable future, North and Central Texas residents will find it much more affordable to rent vs. buying a house. This should be supportive of stronger multifamily fundamentals for years to come.
Construction Costs Remain Elevated & Development Capital has a High Hurdle
Admittedly this is a bit anecdotal, but from all of the conversations I have had with my multifamily developer buddies, while they see a bit of relief in certain cost categories, they also see other categories’ costs continuing to rise. Throw in the potential impact of future tariffs under the "Trump 2.0" regime (although it’s debatable whether or not these will go into effect in any meaningful way), and they all generally foresee construction costs remaining flat at best, with most expecting a modest increase going forward.
Furthermore, securing both capital and debt to start a new project remains difficult. That capital is largely on the sidelines, or they are looking at acquisition opportunities that they can buy 10-20% below replacement cost for existing properties today. That is leading a lot of equity providers who typically fund new development to wonder why they would take development risk at a higher basis when they can just buy existing projects cheaper today. These hurdles should continue suppressing the number of future multifamily starts for a while.
My Takeaways
To me, the Texas multifamily market is a "coiled spring" waiting to be released. We have had over two years of apartment fundamentals experiencing headwinds due to historically high new deliveries, coupled with higher interest rates (which should be headed directionally lower with the Fed’s recent pivot from its hiking cycle), leading to dramatically lower investment sales activity for 2023 and 2024. I expect that in 2025, we will see improvements in both fundamentals and sales activity.
However, I think 2026 will be the year that we see the market accelerate for both fundamentals and valuations. Forecasts show that 2026 will be the lowest year for deliveries in Texas since 2014, a time when the population was significantly lower than it is today. I think that we will look back and see that January 1st, 2025 marked the beginning of what I expect to be a 4 to 5-year bull run.
To go out on a bit of a limb, in 9-12 months from now, I expect new construction properties in DFW (3-5 years or younger) will no longer trade below replacement cost. Similarly, I expect that in Central Texas, 12-18 months from now, these same newer vintages will also stop trading below replacement cost.
If I am correct, that means the "coiled spring" impact should result in a 10-20% valuation increase from today’s levels for the newest properties over that timeframe. Furthermore, I anticipate multifamily values across the spectrum to increase, with those percentage increases more muted for older workforce assets.
To me, this just makes sense – it’s stuff you learn in Econ 101. Builders can’t get equity to ramp up construction meaningfully until they are expected to generate a profit margin. Unless construction costs decline (which I don’t believe will happen per my conversations with developers), a combination of higher rents and eventually lower interest rates must improve, pushing existing apartment values upward before new construction starts increase in scale. My lessons from Econ 101 class tell me that new starts will remain low until existing values go higher.
Said another way, I think the "Multifamily Winter" that was 2023 and 2024 is behind us, and January 1st, 2025 marks the beginning of "Multifamily Spring." I am not saying it's a straight line to "Multifamily Summer" (which I expect around January 1st, 2026), but the weather in the market should generally get warmer week by week.
At SPI Advisory, we have high conviction in this view of the market cycle and will continue to target the acquisition of high-quality assets in strong locations. I am hopeful that we’ll have several opportunities to put out for investment in 2025, as I believe we are off the bottom in values and at the onset of a recovering market, with newer assets leading the way.
Cheers,
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