Avoid the Private Real Estate Deal Trap with Stress Testing

This article was originally posted on Origin Investments’ blog.

The iconic Apollo 13 missive “Houston, we have a problem” came back to haunt “Bayou City” in mid-2014, when the oil market began a descent that didn’t bottom out until early 2016, and again last year as Hurricane Harvey left the city with more than $125 billion in damage. Both misfortunes put a damper on the Houston real estate market and economy, which begs the obvious question of Origin: why invest here?

Most people assume Houston is still in a recovery mode, so it’s a fair question. But despite its troubles, the city has proven to have a resilient job market, adding 48,000 jobs last year and ending 2017 with 4.3 percent unemployment. Yes, it’s a significant drop from 2014, when Houston added 117,000 jobs. But it’s the metropolitan area’s strongest showing since then, and closing in on its historical average of 60,000 jobs.

More significantly, last year’s upward tick in jobs is only one aspect of Houston’s fresh start. The area could add as many as 70,000 jobs this year, according to a University of Houston forecast, and there are many other factors at play indicating the beginning of a huge rebound in the nation’s fourth-largest city.

The Oil Market is Impacting Houston’s Economy Positively

Houston’s oil market has rebounded, with prices now hovering around $60 a barrel — a significant improvement from less than $30 a barrel in early 2016. Over the last few years, oil and natural gas firms have become more operationally efficient in their oil exploration and drilling, and are using blockchain and other technologies to transform their trading practices. They’re now earning more from each barrel and are just as profitable today as when oil prices were $90 a barrel. This has helped transform the Houston market: jobs are back in the oilfields, and in factories making the high-tech drilling equipment for oil and gas rigs. Houston is also vying to become the center of global oil trading and is expected to displace Cushing, Oklahoma, the industry’s current “Pipeline Crossroads of the World.”

Beyond Oil, Houston Has a Diverse Economy

However, the energy business is just a part of Houston’s economy today. The city also has huge life-science and aerospace sectors. The Texas Medical Center is the world’s largest medical complex, spanning over 50 million developed square feet, sporting 106,000 employees and boasting $3 billion in construction projects underway. NASA’s Johnson Space Center anchors a space-science sector that includes Boeing and Raytheon. The healthcare and energy industries are collaborating on a data science consortium to build on the region’s science and engineering brainpower at Rice University and the University of Houston.

Banking and insurance hiring in the Houston real estate market has pushed ahead of the non-recession pace, with Houston banks doing well right now, notes American Banker. In fact, Houston banks are doing so well right now, that four have agreed to be sold in profitable mergers as community lenders are expanding their loan portfolios.

Thanks to these thriving industry forces, the Houston housing market saw its strongest year ever last year with more than 94,000 property sales, despite Hurricane Harvey, according to the Houston Association of Realtors. Building in the Houston housing market has precipitated a construction worker shortage and Oldcastle Building Solutions predicts a 14 percent rise in building for 2018, making Houston next in line after New York City and Dallas in construction spending.

Opportunities for Real Estate Investment

There are many opportunities for real estate investment across Houston’s many submarkets, due to the economic recovery. JLL sees deal-friendly conditions for Houston throughout 2018, with lower asking prices and strength for office, multifamily, retail and industrial properties.

As a corporate gateway market, Houston attracts institutional and foreign investors and its premier properties are attracting significant core and core-plus portfolio deals. A prime example is the $875 million mega-deal by Brookfield Asset Management that closed in December 2017 for the downtown Houston Center complex.

Houston’s thriving conditions presented Origin with the opportunity to buy and update the Stella at the Medical Center apartment complex. Plus, we sold Kingwood Medical Arts, a 90,000-square-foot medical office building in northeast suburban Houston, at a price that represented a 62 percent increase in value, generating a 25.4 percent internal rate of return and a 2.5 multiple on its investment. As Houston’s recovery continues, Origin expects to find similar value-add opportunities like these.