This article is sponsored by Blue Vista Capital Management
Purpose-built student housing is one of the few institutional real estate asset classes that did not exist in scale 20 years ago. Blue Vista raised the first institutional fund specifically targeting student housing investments in 2006 and, since then, what was a niche asset class has transformed into an institutionally coveted sector, with CBRE figures showing $6 billion-$8 billion of annual transaction volume.
Student housing has come a long way
The remarkable growth in transaction volume has been partially fueled by an influx of entrants coming out of the Great Recession, who were attracted to the recession-resistant characteristics of student housing along with the inelastic demand that students had for high-quality housing adjacent to large universities. As student housing traded at a discount to conventional multifamily apartments, investors could acquire student housing properties at a relatively attractive yield.
Student housing interest has continued to increase at a rapid pace over the past decade. Initially, institutional investors were attracted to the sector by opportunities to take advantage of fragmented ownership and increasing sector liquidity, driven by the modernization of the student housing sector from cinder block dorms to purpose-built, Class-A institutional product.
The sector strategy has evolved from essentially “build it and they will come” low-density housing located a shuttle ride away from campus with outsized amenity packages – such as lazy rivers, jumbotron TVs and golf simulators – to more recently focusing on higher-density properties in “roll out of bed and onto campus” locations with practical amenities related to health, wellness and group spaces. Development activity increased from an average of around 25,000 beds delivered annually prior to the Great Recession to almost 50,000 beds delivered on average over the last 10 years.
Heading into 2020, the sector was having its best year yet with 2020-21 pre-leasing velocity well ahead of the prior year and no known obstacles in the way of achieving another year of successful leasing. In what seemed like a blink of an eye, the sector went from flying high to facing its most challenging test with the onset of covid-19.
Coming to grips with covid-19
Universities were some of the first to act during the pandemic, shutting down their campuses and converting classes to an online format for the rest of the school year. Off-campus student housing properties were not shut down, but changes were implemented immediately to protect the health of both residents and staff, with amenities temporarily closing and onsite staff moving to a split team approach.
There were a number of questions that began to percolate about the off-campus student housing sector. Would students still pay rent during shelter-in-place? Would they continue to sign leases for the next academic year? Were universities going to reopen in the fall for on-campus learning? Several months into the pandemic, we are seeing some answers emerge. While we are still in a most uncertain environment, we believe the longerterm outlook for the sector remains quite positive. Additionally, the early prognosis for fall lease-up is encouraging.
In terms of industrywide occupancy rates and rent collection, student housing operators estimate that their off-campus housing has remained approximately 50-60 percent occupied during the shelter-in-place months and owners have been pleasantly surprised by rent collections for April and May, with off-campus student housing only experiencing a bad debt increase of 2-3 percent compared with conventional multifamily that experienced an increase closer to 6 percent.
Student housing operators point to several reasons for the sector’s collections success: leases tied to parental guarantees, 12-month lease terms where residents already expected to pay for the summer months when school was not in session, and, where applicable, management working with residents on payment plan flexibility. Some properties have even seen an uptick in current occupancy as students look to move out of on-campus dorms with shared bedrooms into off-campus units that provide private bedrooms and bathrooms, rather than move home.
Blue Vista continues to see positive pre-leasing for the 2020-21 academic year, albeit at a slower velocity than in prior years, with approximately 70 percent of the beds pre-leased as of the end of May (versus 77 percent pre-leased for the prior year). Marketing strategies have transitioned to a heavy online approach and there are signs that leasing velocity will pick up materially over the summer months.
On the transaction side, new sale processes have generally been put on hold with so much uncertainty currently in the market regarding the state of pre-leasing for the upcoming academic year. Many lenders have also taken to the sidelines, focusing more on their existing book of loans. We believe that there remains a near-term path back to stability for the sector if a majority of universities welcome back students on campus in the fall and the corresponding leasing levels recover back to the performance achieved in prior years.
A resilient asset class
Blue Vista has been pleased with the sector’s promising performance during this remarkable period of uncertainty. We remain bullish on the growth and stability offered by the asset class on a longer-term basis. There is little doubt that the decision between having classes in person or online will significantly impact the lease-up for this fall. However, this is hopefully a short-term obstacle that can be overcome as society moves towards understanding and treating covid-19.
What may have a longer-lasting impact resulting from these shelter-in-place months is the nosedive taken by the US economy over the past several months due to shelter-in-place restrictions, and the corresponding move towards a global recession. With that said, one of the key fundamentals of student housing in the past has been its recession-resistant characteristics and its negative correlation to GDP growth.
The value of a college education is still meaningful, with college graduates earning an average salary premium of 75 percent compared with those who only have a high school diploma. Furthermore, college graduates experience a significantly lower rate of unemployment, as seen from April data that reported an unemployment rate of 17.3 percent for those with a high school diploma or less, 15 percent for those with an associate’s degree and 8.4 percent for those with at least a bachelor’s degree.
Additionally, university enrollment has grown during every recession since the 1950s, as people go back to school to gain new work skills during economic and employment disruptions. Although each past recession has had its own unique drivers, student housing and top-tier colleges have remained resilient, and we believe that trend will continue during the current downturn.
While some owners will be able to weather the covid storm, there is an expectation that some will not, and that one’s misfortune may be another’s opportunity. We do not expect the distress in student housing to be anywhere near that seen in the hospitality and retail sectors, but we do believe there will be distressed opportunities related to student housing properties with the following characteristics:
•Existing assets that were distressed pre-covid due to a variety of factors, including aggressive underwriting and pricing, poor supply/demand fundamentals and inexperienced operators;
•Development projects that have been delayed and are in need of rescue capital;
•Existing owners who are not well-capitalized and facing near-term debt maturities;
•Non-performing loans that could be acquired directly from lenders and could result in a resetting of the valuation basis;
•Partnerships with universities to augment and/or replace older functionally obsolete on-campus housing, due to current preferences and space of new social distancing requirements.
Student housing investment managers who are most likely to succeed will need to be experienced in the sector and well-equipped to employ institutional-quality management practices to identify best-in-class opportunities and, ultimately, grow income. While there is some uncertainty in the near term, we believe that the long-term outlook for student housing remains bright and we hope to continue helping to lead the industry forward into its next phase of expansion.
Student housing can benefit from change
There has been some debate about whether the current environment could lead to changes in how higher education is delivered, and about whether off-campus student housing is positioned to benefit or suffer from those changes. We see a number of factors that lead us to believe the former rather than the latter:
1 Online education is proving not to be a substitute for the in-person dynamic living/learning experience that exists on college campuses. Between allegations of co-ordinated cheating efforts, class action lawsuits by parents alleging that they are not getting the same value from the online experience, and negative reviews by both students and teachers alike, the current environment is showing that online learning can be a useful supplement to in-person classes, but not a replacement. For example, universities with a focus on STEM subjects need laboratories and equipment that is not available online. Additionally, despite classes currently being delivered online, our properties have remained well occupied with many residents indicating that they would still want to live near campus versus at home with their parents in the fall, even if classes continued online.
2 Many dorms on campus are ill-equipped to operate in a social distancing setting and universities may need to look for alternative housing options for their students. Universities looking to de-densify their dorms for the fall will require off-campus housing partners to achieve this goal. Typically, off-campus purpose-built student housing offers private individual bedrooms and bathrooms for each resident, a design feature that will likely be even more in demand today. There may also be opportunities for universities to master lease beds directly from off-campus student housing owners, which may be a quicker and cheaper alternative versus redeveloping existing on-campus housing.
3 Some schools will end up as “winners” while others will be “losers” as a result of the pandemic. Small liberal arts schools and lower tier “second choice” schools are generally poorly positioned to survive a financial disruption, whereas larger “Tier 1” schools will remain schools of first choice. Tier 1 schools have more control over their admission levels and have more financial stability given diverse streams of revenue. A flight to quality at Tier 1 universities will likely be a driver for future investment activity in the sector, as the larger “Power 5” conferences with stable and/or growing enrollments with strong fundamentals become even more attractive investment destinations.