The real estate stock index moved down 2.6% last week underperforming the Russell 2000 (-0.9%), the NASDAQ (-0.8%) and the S&P 500 (-0.7%). The office sector remain relatively stable although there was significant weakness in both the multi-residential and Retail sector (office sector index declined -1.8% but multi-residential and Retail were down -3.6% and -4.0%, respectively). The main reason for the stronger office market performance (relative to Retail or multi-residential sector) is that unemployment has remained relatively stable, but retail and multi-residential declines have contributed to very weak consumer spending. It was a quiet news week for the office REIT’s, so we blame the decline and underperformance versus the broader markets on the legacy link to the financials.
So have the fundamentals of the office market (rental rates and occupancy) deteriorated as much as the valuation index has indicated? Absolutely not. The office fundamentals have been resilient in the aftermath of the sub-prime and financial market melt-down. In certain markets, such as New York (the largest office market in the country) and California (4th largest office market), these markets have experienced a significant deterioration in both rental rates and occupancy growth. However, in other large office markets such as Dallas (5th largest office market and 4th largest city in the country) and Houston (6th largest office market and 5th largest city in the country), the rental rate is continuing its growth and vacancy is dropping due to a stable work force and very stable employment growth.
The general economic slowdown doesn’t keep Dallas and Houston from the nation’s top spot in population growth. Combined, Dallas and Houston are enjoying the biggest population increase in the nation with over 358,000 new residents. Don’t get me wrong, the population growth for the Dallas and Houston region has slowed, but the two major cities still added more people in 2006-2007 than any other metropolitan area in the country, according to new U.S. Census Bureau statistics.
Both Dallas and Houston have lower unemployment compared to New York and Los Angles (4.7% in average compared to 4.9%). Both Dallas and Houston’s projected economic growth is expected to be around 1.5% for 2008 (much higher than the projected 0.9% for both New York and Los Angeles). The C/E ratio (cost per potential earning ) is significantly lower in Dallas and Houston compared to New York and Los Angeles (if you are used to buying stock, C/E is the same as the P/E ratio, so a lower C/E means it is a better asset). Both Dallas and Houston remain “Rising Markets.”
Both of these two major cities’ valuation has not kept up with its rent growth or the valuation growth we experienced in the last two years in other top 10 major office markets in the country. Rental rates have not kept up with other major cities due to the higher historical vacancy, which frankly is evaporating. We see significant growth potential in both of these markets with lower risk factors. We believe the population will continue to grow in both cities and employment will continue to stay strong. The fact that both cities have a lower cost of living compared to other top office markets has been a contributor to employment growth and faster employment migration. Also, Texas is centrally located, which reduces transit and delivery costs by half compared to Los Angeles and New York (no surprise as the Port of Houston’s cargo tonnage has doubled in the last five years). This has been a significant influencer on Fortune 500 companies migrating to the area (both Comerica and Fluor recently moved their HQ’s to Dallas).
So, we have stronger underlining economic growth, lower valuation, stronger absorption, lower risk and more room for rental rate growth. What keeps investors from looking more favorably in both of these markets? Could it be the herd mentality at play?
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Good comments. RealtyTrac just reported that a total of 10,700 Texas properties started foreclosure in March, down more than 16 percent from the volume of filings recorded in March 2007. The March foreclosure figure also represents a decrease of almost 13 percent from filings reported in February of ‘08. Texas is a hidden jewel that more investors should investigate.
Zaya, terrific column. We’ve been singing the praises of Dallas, Houston and Austin for a long-time. You’re right on target about how these markets are holding up and how they compare to other “major” cities and office markets. There remains a misperception today of particularly how Dallas is fairing, compared to eons ago. Dallas is not overbuilt and we continue to see rents increasing - the new construction is more expensive than the existing product to lease and construction costs remain high - we’re not going to see the excess of the late eighties again. We appreciate your insights and look forward to more of your blogs…becuase facts do matter!
Facts:
Dallas - Valuations are limited by replacement cost since it is so easy to build, and rent growth, with the exception of a few choice properties, is limited by the amount of available space.
Houston - Far better market, but nearly all of the current absorption is driven by the oil and gas sector - a very cyclical industry.