Mid-rises and small multi-family in the Inner Loop

11 Replies | Houston, Texas

I've looked at a lot of smaller multi-family properties in the Inner Loop as buy/hold options (by smaller, I mean from a duplex to a six-plex). As I drive around the area to look at them, I'm struck by the quantity of mid-rises that continue to go up in Midtown, Montrose, Rice Village--basically, everywhere it seems. 

This got me thinking about what the expansion of mid-rises means for the market in smaller multifamily rentals. In particular, I wonder if the ongoing increased supply of mid-rise housing will suppress demand for traditional multifamily rentals from duplexes to quadplexes. Renting in a mid-rise gets you a newer place with modern amenities, while most of the multifamily housing stock I've seen around the Inner Loop is older construction, some without parking or HVAC.

For one example, I was just in the Montrose area north of Richmond and west of the 59 spur, where there are a lot of older small multifamily properties renting rooms. I know this because there were at least 5-6 for lease signs in just the several blocks I drove around, suggesting pretty high vacancy rates. And along the southern strip of this area, at Richmond & 59 there's a relatively new mid-rise advertising 1/2 BR apartments (I looked at this place had quite a few vacancies as well for what that's worth).

Of course, if there is an oversupply problem, it would cash out in pricing, and the rough numbers I looked at bore this out. The rental prices in the traditional smaller multi families in this area seemed to be around $1/sqft, while the nearby mid-rise was charging $1.7/sqft for similar places.  

So the big question is: Does the rise of the mid-rise in the Inner Loop spell decline for the market in rentals of units in smaller multi-family? Or are there other factors that cut back against this trend? Thanks for any thoughts on this.

I would honestly be surprised if you're seeing rent at $1/sq ft. in the Montrose area, and it's a livable space. Most of the things I'm seeing are in the $1.75 - $2 range. But if you're seeing those numbers, I would wonder whether you could get closer to $1.75/ft with a little upgrading.

Another factor could be that this time of year there is a very high turnover of units across the board. Late spring and early summer tend to be high-volume moving times. 

Ultimately, though, I don't think the mid-rise market will crowd out the smaller 2-6 unit complexes. The fancier mid-rises appeal to a certain market demographic (yuppies), and there are plenty of other renters who fall outside that demographic. Many people just don't want to live in a complex with 50, 60, or 100 units. 

The demand may also be highly dependent on the sub-market. In the Heights, for example, duplexes, triplexes, and quads are renting almost as fast as they can be put online, at rates closer to $2/ft. A lot of that is the neighborhood "charm," but for as long as I've lived there (7 yrs), the market for small multi-family has been popping.

@Kyle Bryant : Thanks, good info. The $1/sf figure I got was based on a small sample size of three places, all of which were in older buildings without central HVAC or other modern amenities. Two of the three were first floor units. They were also in a smaller submarket of Montrose (east of Montrose and near the 59 spur) that has older, lower-quality housing stock. And right now the city is tearing the hell out of those streets to install new storm drains in that area, so the lower prices may just reflect that relatively small submarket at this particular time.

Beyond mid-rise v multifamily, the bigger question is whether the Inner Loop is being so saturated with housing supply  that it will drive down rents regardless of type.  

@Dave Fagundes  

"So the big question is: Does the rise of the mid-rise in the Inner Loop spell decline for the market in rentals of units in smaller multi-family? Or are there other factors that cut back against this trend? Thanks for any thoughts on this."

Short answer, No.

Mid to high rises are a different class of properties compared to small older multi families. Classes D to B- in the small units because of age, condition, and location. While the mid to high rises are class B to A. Different demographics as @Kyle Bryant stated.

Gentrification can also plays a role in these small milt-family properties.

Vacancy rate can vary because of quality, management issues, hurricane, economical turn down, high crime, bad schools, etc...

So, I would look for class D to C- property in a solid class C+ to B area and not worry about the mid to high-rises. I would look at that as opportunity especially because of the type of property you are looking to buy.

My apartment, for example, was a class D- property in a class B area. After a complete renovation and turnover, it's a class C+/B- property and, we are above market in rents per S/F while maintaining high occupancy. In Katy there has been a huge influx of new apartments over the years, to the point of being overbuilt. however, we are still maintaining a high occupancy rate because of the class differences.   

Lot of excellent information! Thanks @Dave Fagundes . @Dave Chapa and @Kyle Bryant for posting/responding this question? 

I would like to add-on to Dave F question related to inner loop. What is your opinion on mid -rise SFH buy and hold strategy in inner loop? I was always interested in Buy and Hold investment properties in Houston inner loop ( Heights, rice military, mid town , etc). In near future, I have to decide weather to sell my primary mid -rise SFH and convert it into buy - hold or Air BNB?

Rental are somewhere from $2.2 K - 3K /month for $1/ft2 - $1.4/ft2 ( sample size of 4-5 homes). As of today, Lot of rental available in market.  Thank you in advance!

@Dave Fagundes Just my thoughts on inner loop properties, the rent has been climbing since last year. 

Class B inventories is getting lower and lower in montrose especially where teachers, bartenders and entry level analysts are either squeezed out or pushed to pay mid rise or new complexes with 2-2.5 /sqft. 

I currently own 28 units around montrose and I am averaging around 1.69  /sqft with very low turn over. I am planning to slowly increasing rent this year as the Houston rental market has been stronger. 

Great discussion on this thread @Dave Fagundes , Account Closed. I live in the Heights and am currently looking to purchase a 4-12 unit MF property in the area. I've also been looking around Montrose and recently was corresponding with the owner of an off-market 4 unit who was looking to sell (connected with him via my direct mail). The property is in a great location and needs relatively minor upgrades to increase rents (currently below market). He's valuing the property at a 3 cap which simply isn't an attractive investment. If using financing, the property is cash flow negative. I'm finding this to be a common theme in the Montrose area. 

I know a developer that builds primarily in the Heights who I've had discussions about possibly building a 12 unit efficiency apartment in the Sunset Heights area (we have a prospective lot identified). Based on an initial proforma, we may be able to end up with an 8 cap after construction assuming rents at $1250/month. With cap rates in the Heights typically around 6, this results in significant value add after the property is stabilized. This sounds attractive but I lack experience in new construction and am not comfortable making an investment alone. I'm happy to bring this deal to an investor who has experience in this arena that would be interested in partnering. Let me know if any of you have an interest or know of someone with experience in MF new construction that would like to explore this opportunity. Thanks all! 

Great comments, all, thanks for the input. As I continue to run numbers on smaller multifamily places in the inner loop, I keep finding the same outcomes others have identified: even if you knock the asking price down a bit, any financing results in negative cash flow, while an all-cash offer yields a return so small you'd be better off putting your money in a mutual fund. 

From what I've seen talking to agents the reason is that the market in MF is priced along the same lines as residential SFHs. Sellers just look at comps and price per square foot, and conclude that they can get about the same as similar places--which is probably true. Problem is that investors think in terms of totally different metrics--cash flow, cap rate, cash on cash. When I talk to realtors about these properties, it's like we're speaking a different language.

The macro trend seems to be that property values in the inner loop have risen at a faster rate than rents, which is typical in a hot market and also one indicator of overpriced residential real estate. Shiller, about as good an authority on US home prices as you're going to get, uses a price-rent ratio of 20 as the threshold for overpriced property (and on a market-wide scale, as a measure of a bubble). All the places I've seen are around or above that number. (Houston's P/R ratio is one of the lowest in the country among major cities, but that doesn't say much about the Inner Loop submarket because the city limits are so spread out.)

So while I like the idea of Inner Loop multifamily in theory--great location, strong long-term value expectations, some diversification of tenants--I'm growing skeptical that now is a good time for this market. Sure, there's always the possibility of finding the rare black swan opportunity on a probate list or something, but in the near term I'm starting to think it makes more sense to think about different markets like larger apartment complexes where the pricing is based on rental income, not SFH "comps", or looking at smaller or more outlying markets where sales and rental values are more in sync.

@Dave Fagundes I came to the same conclusion. I found several properties that were too tight on the numbers, passed on a 4 plex in the Heights. that's why all my recent purchases have been outside of Houston, the Katy and Bellville area. 

I'm really liking the more rural areas like Bellville and find my self looking further out from Houston for more MF.  Also, I live in the hour and a half west of Houston so that helps.

However, I still keep looking in Houston for that "black swan". :-)

Thanks for all the great info. I am a new investor and I have been studying the markets in EaDo and 2nd and 3rd wards in Houston. I feel priced out of the Heights, Montrose and Midtown. Do any of you have an opinion on this? I live outside the loop but want to buy and hold SF or small MF (duplex or triplex) inside the loop and this appears to be the only area left with property under $300K. 

@Heather Varnado From what I've seen, EaDo and 3d Ward are very different markets. EaDo is much more industrial (formerly anyhow) that is moving mainly toward mid-rises and other large housing developments. There is probably less expensive housing stock but not sure how much demand for it there will be when it's surrounded by sleek new apartment buildings. Museum Park, for example, has some SFH and MF but they are mostly being acquired by developers to tear down and build fancy new condos, which are probably the highest and best use of the land right now in that particular neighborhood. Bottom line, not sure how good an idea it would be to buy MF in an area that is trending strongly toward different kind of development overall, even if there is something affordable.

In terms of 3d Ward, the prices drop dramatically once you get on the east side of South Freeway. There's an interesting pocket east of Almeda and west of S Freeway that might still be more affordable, though that is really an adjunct to Museum Park so it too may be part of the sweeping trend toward tear-downs and condos, and not that cheap anymore. The big question I've asked in looking in 3d Ward is whether the trend toward development will stay hot, jump over S Fwy, and start picking up that area's values, or whether S Fwy will remain a visible line of demarcation in value. Plus, if there's a housing downturn, it's the frontier of development/gentrification that will suffer first, and most, so there is risk involved in that. But if you're looking for buy-and-hold, then a downturn is less of an issue since (1) rents tend to stay stable or even increase when housing values decrease and (2) if you're doing B&H then you can ride out a downturn.