Back to school

Student halls are not just hangouts for undergraduates these days. As some highprofile London projects have shown, student accommodation has become an attractive asset class for private equity real estate investors in the UK. By Robin Marriott

Turn left out of the King's Cross train station in north central London and walk east along Pentonville Road. Dodging the hamburger wrappers and backpackers, visitors pass a betting shop, a luggage shop, an internet café and numerous fast food counters. Walk further still and you come to a hodgepodge of uninspiring buildings, including the headquarters of senior citizens charity Help the Aged.

“London has a strong student body and the Mayor of London [Ken Livingstone] is promoting the city as a world-class learning center. You are seeing increasing numbers of foreign students here particularly from America, China and other parts of Asia, as well as Europe.”

Given the drab surrounds, it makes it all the more surprising to find a new development rising 16 floors above the street complete with twin towers decked out in funky two-tone blue panels. The building's ground floor is being fitted out with trendy shops and smart cafes.

This building—the only new development currently visible from King's Cross station—is not the headquarters of a cutting-edge media company or an edgy architectural practice—rather it's one of London's newest student accommodation blocks.

The first of 1,045 students began renting studio flats and private apartments at Nido King's Cross last month. For £180 (€264; $365) per week for a studio (or £120 for shared apartments), students can live in high style with access to free internet service, separate study rooms, a gym and even laundry cleaning with pick-up service. Security is provided for by swipe cards.

Nido, which means “nest” in Spanish and Italian, is the name of a student accommodation platform owned by The Blackstone Group, which hopes to scale up the business across Europe starting from its London base. As well as the £95 million investment in King's Cross, the firm has a second, larger project planned for the City. When both projects are complete, Blackstone will operate 2,200 upmarket student beds in London—with more to come.

Student demand
According to market participants, there is a strong demand for more student housing in an international city like London, which attracts students from all ends of the earth. Stuart Grant, a managing director of real estate at Blackstone, said the firm began looking at the sector three years ago and recognized the opportunity in the space thanks to growing demand and a shortage of supply in London and other key markets.

“London has a strong student body and the Mayor of London [Ken Livingstone] is promoting the city as a world-class learning center,” he says. “You are seeing increasing numbers of foreign students here particularly from America, China and other parts of Asia, as well as Europe.”

There are 300,000 foreign students in Britain, which makes the country the second largest importer of students in the world after the US. Moreover, the supply-and-demand equation in London, where Blackstone is focused, points to increasing rents. According to the firm, there are an estimated 33,000 institutionally owned and operated student beds in the city. The dorms are running at 100 percent occupancy and demand is running at levels high enough to fill 120,000 beds, notes the investor.

Students coming to London from China are one of the three major groups fueling demand, according to Blackstone. A side effect of Beijing's loosening grip on foreign travel is a 62 percent increase in Chinese students studying in the UK since 1998. Secondly, students from recently admitted EU member states are also putting pressure on rents and continued enlargement of the EU is expected to bring an additional 20,000 students to the UK from Europe over the next five years. The third group come from the US, with a fair number being attracted to London's storied business schools.

Private dorms
A fundamental shift has taken place in student housing in Britain. In the 1990s, it was construction companies such as Jarvis who spotted an opportunity in student accommodation by buying properties from universities and taking over the management contracts as well. Nowadays, private equity firms, real estate fund managers and operators with private funds have muscled onto campus.

There is little mystery why private equity firms are moving into the space. About three years ago, investors saw that returns from UK commercial property were dipping after an unprecedented bull run, so many began scouting fresh opportunities. Upon close inspection, some concluded that demographic trends and economic data indicated that student accommodation could be an attractive investment proposition.

“The market has moved,” says Trishul Thakore, vice president at placement agent M3 Capital Partners. “It started with universities selling stock on long leases that they had built or with entering into outsourcing contracts. People saw that as dry, long-term investments with inflation-linked rental uplifts. Now purpose-built new accommodation is being built typically off-campus in city centers.”

Thakore—who helped Britain's biggest student accommodation company, Unite, close its £370 million UK Student Accommodation Fund this year—explains how the sector is set to outperform traditional asset classes. “Expected total returns are approximately 200 to 300 basis points higher than core real estate for stabilised student accommodation properties with good prospects for rental growth,” he says.

Unite's fund is Europe's largest specialized vehicle focused on owning and acquiring direct-let student accommodation in the UK, but there are other significant players that have moved into managed student accommodation funds recently. Pan-European property fund manager firm Cordea Savills recently raised a Student Hall Fund, having spent six months in 2006 researching the sector. It tapped some of the unsatisfied demand for Unite's vehicle and returned 19.5 percent in its first year. The exceptional return has been helped by yield compression; the long-term target of the ten-year vehicle, however, is 10 percent.

There are others firms investing in the sector, too. One of those with a longer pedigree is University Partnerships Programme, a company jointly owned by Barclays Private Equity and London LBO shop 3i. The private equity firms backed a management buyout of the business in 2004 when it was a division of construction company Jarvis, which began by building blocks for universities via private finance initiatives in the 1990s. Another investor in the space is London-based Brandeaux, whose Brandeaux Student Accommodation Fund owns 10,000 beds, is into its eighth year of operation and targets annual returns of 8 to 10 percent a year.

Class risks
There are varying operating models at work in the industry, but at the higher end of the risk spectrum are funds that own an operating company that manages planning, construction and direct leasing risk.

Renting rooms directly to students can obviously be more challenging than other sectors where leases are typically longer than a school year: Not only does the operating company have to fight for footloose—and increasingly demanding—students in a competitive market such as London, but once it gets them it faces the challenge of “re-leasing” its properties each academic year. To an extent, Unite and Blackstone mitigate the present risks by issuing 41- or 42-week leases and locking students in for the whole term.

Few students move during the academic year so companies don't have to worry about filling rooms during a term, but companies in the student accommodation business also face management challenges. For example, at the end of each term, the rooms need to be readied for the next occupant—not necessarily the easiest thing to do as anyone with a passing knowledge of student cleanliness and hygiene can attest. In addition, reputation is everything: Fickle students will rapidly spread the word if a property fails to match expectation.

For Blackstone, some of the risk is mitigated because the firm's properties are not dependent on just one or two nearby universities: Its blocks are situated to take advantage of numerous academic institutions in London. Unite is following suit by significantly increasing capital deployment in London and investing in properties that can also service multiple universities.

Moreover, to balance the local market risk, globetrotting Nido executives are busy striking up longer-term deals with universities across the world. New York-based Blackstone has the obvious home advantage of signing up American academic institutions to so-called “nomination agreements”—essentially long-term commitments by a school to send students to a company's halls. It is also adding to its stable of clients by visiting academies as far apart as Hong Kong, Mumbai and Montreal. Longer-term lets with universities and short-term lets with individual students can help mitigate risk by creating a “hybrid” of leasing risks, according to Grant.

Cordea Savills operates a variation on the Blackstone and Unite investment models, seemingly at the less risky end of the spectrum. Though Cordea Savills directly leases around a third of its assets to students, two-thirds of the £300 million invested to date are in properties subject to nomination agreements or, safer still, long-term leases to student housing operators.

Last year Cordea Savills studied the British market over a period of six months, compiling an internal report with intelligence on every university student hall across the UK. This helped it steer away from cities such as Liverpool and Lincoln, where it found oversupply as a result of significant amounts of completed halls. This sort of oversupply makes direct leasing of student accommodation very risky, according to Andrew Allen, head of research and strategy at the firm.

But is has also found opportunities. For example, in March it bought a 179-room student hall development in central Loughborough, a short walk from the local university. With more funds chasing student accommodation, properties have become more expensive to buy and Blackstone's Grant says yields have fallen 2 or 3 percent. But a wider issue might be what happens in an economic downturn.

In a downturn
Given that the UK government has a target to increase the number of young people going through university, there is little wonder why some see student accommodation as a safe bet even in weakening economies. This thesis could be tested if the subprime crisis in the US fosters a widespread economic malaise in the UK.

“There is something quite strange about student halls,” says Allen of Cordea Savills. “The fundamental drivers of demand are nothing to do with economies. The worse the economy gets, the longer students study.” He notes this has been the case in Germany, which is only just beginning to climb out of economic stagnation.

However, Allen does not go as far as to say that student accommodation is immune from an economic downturn. In fact, some of the challenges to investing in student housing are discussed in a recent report published by RREEF, the infrastructure and asset management arm of Deutsche Bank.

In “Prospects for Student Housing Investment,” published in April, the investment firm says that the student accommodation sector has gained awareness globally, particularly as three student housing real estate investment trusts (REITs) have launched in the US since 2004. In the US, the student population is growing twice as fast as the US population, the report notes. It also says university-owned accommodation has failed to keep up with demand and the private sector has been slow to fill the void.

However, the report concludes that the student accommodation sector could be hit hard in the event of an economic downturn. “The demand for student housing overall is less cyclical than for other real estate categories,” the report concludes. “Even so, student housing projects may see occupancy fluctuate over the course of the business cycle, as more students opt for less expensive units during recessions.”

This could affect the posh upmarket dorms that Blackstone plans to roll out and investors in student accommodation might find students more concerned about cost—and less interested in fancy trimmings. Still, the concept has yet to be fully tested in the UK and, for now, there is little sign that student accommodation investment is a passing fad.