PERE: How has US student housing become more of an institutional property type?
Christopher Merrill: Interest in the student housing segment has grown tremendously since we started the business over a decade ago. The driving factor is a lack of housing as most public universities across the country can only house 20 percent to 25 percent of their students on campus. Given the lack of funding, universities need private developers to create suitable extra housing.
When we started, many were unsure of the liquidity or acceptability of the asset class. That fear is dissipating with the increase in market size, performance, quality, demand drivers, and increase in strong local operating firms. The asset class is very similar to other traditional real estate asset classes such as multifamily in how it’s managed, how it’s operated, the lease structure – it’s very financeable. You have seen a market grow from infancy over the past 15 years to a significant sized business, most likely in excess of $300 billion. Where once there was limited liquidity, you now see buyers from public REITs, large pension funds, foreign buyers and high net worth groups. Clearly investors are more comfortable with the asset class.
PERE: You talk about tremendous demand currently. What’s driving this interest?
CM: Performance. You look at how resilient this asset class was during the global financial crisis. You saw these properties hold occupancies and preserve capital. At the same time, we can receive yields above traditional multifamily assets – in some cases 100 basis points to 200 basis points. So, what you have is a real estate asset class in which a unique arbitrage exists. That is rare.
PERE: What are the challenges to deploying capital?
CM: The market is local and fragmented. Many folks came with large sums of capital and didn’t have the network or infrastructure to focus on smaller transactions. We purposely limit how much capital we raise as the majority of investments are single asset acquisitions or developments. One needs to be patient as sourcing opportunities is not easy, and you also have a lack of transparency as each university market is different. There are not many investment markets left in which one can take advantage of opaqueness of information.
PERE: When you started your business, were investors interested in in opportunistic or core investments?
CM: The core market didn’t real exist when we started the business as we were really creating the product. Over time we have seen interest in our open-end core fund as investors see the benefit of consistent, low-volatile income returns. After the GFC, we launched the first ever core fund targeting demographic segments, a great complement to our opportunistic fund series. Having raised over $5 billion across our funds, we now see investor interest in both the core and opportunistic return profile.
PERE: Because there’s more competition driving up pricing, is it making it more challenging to hit return targets?
CM: Yields have come down but liquidity has increased, so risk has been taken out of the space. When we started, we might have been able to get 8 percent or 9 percent development yields, but there wasn’t as much transparency and liquidity. Most development yields have come in 100 basis points to 200 basis points, but now there are more buyers and more liquidity that’s taken some risk out of the market. However, the spread between multifamily has remained consistent. I still find it odd one can get outsized returns for assets that have shown the ability to preserve capital in a down market.
PERE: What is your outlook for institutional investment over the next five years?
CM: I think people are very concerned about traditional asset plays and are looking for assets that are more resilient and have more demographics associated with the demand drivers. This will continue to drive the market forward but new entrants will make mistakes.
PERE: Any idea how much the sector will continue to grow?
CM: We are seeing solid supply growth but in a lot of situations it is replacing older, outdated on or off campus housing segments. There is a lot of room for this segment to grow. You will likely see student housing becoming a larger percentage of investors’ overall multifamily exposure.