Digging into Austin
Topic:
Choosing the right market to invest in is critical to the success of an apartment investment. We’ve experienced it firsthand. The pandemic knocked down high-flying areas like the San Francisco Bay Area and accelerated markets like Austin, TX. Yet that’s not the whole story. An otherwise great market can have poor performing submarkets. That’s happening in downtown urban areas across the country.
We purchased a 300-unit apartment property in southeast Austin in February 2020. One month later, the Covid lockdowns hit. While rents dipped in 2020, all properties in Austin took off in 2021. It was already a high-growth market, but the pandemic poured rocket fuel on it. People fled high-cost areas like the Bay Area and arrived in Austin. Rents grew 30%, and valuations were at all-time highs. We couldn’t pass up this opportunity and sold our property in late 2022—at a price well beyond our initial underwriting.
I doubt we could’ve replicated this in downtown Austin. Since Q1 2020, rents in downtown Austin have only grown 9.5%, according to RealPage. The broader Austin MSA is up 18.6% in the same period (down from a high of 30% in Q3 2022). This suburban versus urban dynamic plays out across the country, too. Downtown Minneapolis has seen rents fall 1.4% since Q1 2020, yet the entire MSA is up 13.3%. Even in great markets like Austin, downtowns have underperformed.
An influx of new apartment supply, prolonged work-from-home policies, surging office vacancy rates, and political policies have made urban areas some of the least desirable pockets in otherwise great markets. As Jed Kolko, former Under Secretary for Economic Affairs, points out, “even as [the] pandemic fades, people are still leaving big cities.” People continue to move to the suburbs. In fact, mid-size cities and low-density suburbs of major cities are the fastest growing according to the latest Census data.
These aren’t rural communities, but places with easy urban-like amenities. Housing tends to be more affordable there. And longer commutes to the office are more bearable given a hybrid work schedule. This dynamic is exemplified by Austin individual submarket rent growth data.
The top performing submarket, San Marcos, isn’t even in Austin. It’s an area south of Austin that encompasses San Marcos, Buda, and Kyle, TX. Highlighted in blue are what were traditionally considered two of the most desirable submarkets for investment, South Austin and Downtown. South Austin is the “cool” area with new boutique hotels, high-end shopping, and traditional Austin weirdness. However, it and downtown were two of the worst performing submarkets. Southeast Austin, where we owned a large property, produced rent growth near the market average. Lastly, the submarkets in green are in and around The Domain. Known as Austin’s second downtown, The Domain is growing rapidly. It has all the elements of an urban environment with the ease of a suburban mall.
If you want to take the Census Bureau’s advice, cities like San Marcos, Pflugerville, and Georgetown were the places to invest. Their populations are growing faster than national averages and their rent growth shows it. Despite the positive traits, higher cap rates in those markets might have scared off investors. Higher cap rates tend to indicate less buyer interest, making it more difficult to sell. It also usually indicates slower growth, but that didn’t happen here. Investors in these markets benefited from 1) a higher initial yield, 2) higher rent growth, and 3) cap rate compression…especially if they sold near the peak. There’s no better combination than this.
One might expect the core submarkets like downtown Austin or south Austin to recover faster over the next five years. They’ve been laggards within the metro and remain desirable places to be. However, these two submarkets are the most expensive. And it’s not even close. Rents in downtown Austin are $1,000 more, on average, than the entire MSA. Add historical levels of new supply to the equation and it’s not a surprise that RealPage expects the hangover to last longer.
Renters are chasing affordability. That’s why so many tech workers have left the San Francisco Bay Area for places like Austin. RealPage’s 5-year rent forecast suggests more of the same. Affordable outlying areas like San Marcos to the south and Pflugerville to the north remain high on the list. As do areas in and around The Domain where neighborhoods continue to gentrify. While rent growth is projected to be tepid in the high-cost submarkets, those areas remain good candidates for value-add projects. The higher overall rents allow for greater room to improve units and charge more.
The submarket an investor chooses is critical. It’s important to line up the correct submarket with the relevant business plan. This will maximize investment results.
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