What’s Driving the Boom of Commercial Real Estate Investment in Student Housing?
The student housing market is hotter than ever, particularly among foreign investors. As we noted in a recent article, roughly 20 percent of capital coming into the US student housing sector is sourced from abroad. This is a staggeringly high number when compared to the multifamily housing sector, for which cross-border capital only accounts for 5 percent of total investment.
Yet it isn’t just foreign investors who are being lured in by the student housing sector; US-based investors are also starting to realize the potential of student housing.
Colleges and universities have always needed off-campus housing, so why is it that the sector is only now starting to attract investors in droves? We decided to investigate the trend: here’s what we learned.
Student Housing, by the Numbers
There used to be a time when college students had only a few housing options: live in an on-campus dormitory, lease an apartment in town, or live with their parents and commute to school each day. Most students tried to avoid the latter option. On-campus housing wasn’t particularly glamorous (the average dorm is 51 years old!), but off-campus apartments tended to be equally run down. When it came to housing, students didn’t have many appealing options to choose from.
Commercial real estate investors saw this lack of quality housing supply as an opportunity, whichfueled a boom of student housing development. Many of the properties being constructed were luxury buildings, loaded with so many amenities (roof deck pools, fitness centers, ground-floor retail, and restaurants) that it became difficult to tell that these complexes were tailored to students. Below are a few key figures that underpin the boom in student housing.
- In 2016, developers delivered 47,800 new beds in time for the fall semester. Developers are on pace to deliver an equal number of new beds in 2017, a slight dip from peak construction in 2013 and 2014 when more than 60,000 new beds came online each year.
- Student housing typically leases on a per-bed basis. In 2016, the average per bedroom rental rate increased 3.6%, with occupancy also increasing. The average occupancy rate for new student housing units is now in the mid-90 percent range. Stabilized student housing properties hover around 99% leased during the school year.
- Acquisitions of U.S. student housing skyrocketed in 2016. The industry saw more than $9.8 billion in transaction volume, which is $4.2 billion more than 2015’s volume, and more than three times the 2014 total. 2016 was the sixth consecutive year of all-time record transaction dollar volume, according to CBRE.
- Student housing continues to appreciate at record rates. On a price per bed basis, student housing reached a record high in 2016. The $66,386 per bed average was 10% higher than 2015 and 30% higher than in 2014.
Financing Trends have made Student Housing More Attractive
Generally speaking, commercial real estate capital markets have been strong over the past few years. Banks have been offering low interest rates and institutional investors, seeking to diversify their portfolios, have been pumping money into the commercial real estate market.
Since the November 2016 election, Treasuries have continued to rise and spreads have significantly compressed. Some sectors are feeling the squeeze as a result—but not student housing. Cap rates for student housing have remained largely untouched.
Student housing has benefited from several financing trends:
- Borrowers are increasingly able to use forward rate locks, enabling them to lock in rates in the Spring and close deals in the Fall, when students start paying rents and generating revenue. Investors carry additional costs by going this route, however, because they’re required to hedge risk for a current rate and hold the burden of ensuring that the property leases up as anticipated.
- Commercial mortgage-backed securities (CMBS) lenders have been more competitive and are offering wider pricing in the student housing sector as of late. This has opened the door to student housing for investors in secondary and tertiary markets, where Fannie Mae and Freddie Mac are less likely to get involved. When securitized debt is available, it provides a valuable option for a segment of the student housing market, particularly for complicated deals that are less attractive to more traditional lenders.
- That said, Fannie Mae and Freddie Mac are still highly active in the student housing sector. In 2016, the GSAs purchased more than $4 billion in student housing loans, a dramatic 27% increase over the year before. Fannie Mae provided the majority of the share ($2.6 billion compared to Freddie’s $1.6 billion).
- Institutional investors, including pension funds and life insurance companies, are starting to enter the fold in greater numbers. For example, TIAA-CREF announced it was actively targeting the purpose-built student housing sector by purchasing a 427-bed property next to the University of North Texas.
Most institutional investors, especially life insurance companies, tap out around 65% loan-to-value, which favors major metro markets and towns with large, state-run universities. However, when assets fit their criteria, financing from life insurance companies can be very attractive on multiple levels including early rate lock options and flexible pre-payment provisions.
- Balance sheet lending continues to be a significant source of capital, notes Walker & Dunlop managing director Will Baker, typically taking the form of non-recourse bridge loans for deals that are not ready for permanent debt or properties in the process of lease-up.
The Outlook for Student Housing
Real estate investors are still bullish on the student housing sector. Yes, more students are enrolling in online classes and in theory that would weaken demand for student housing. However, enrollment in on-campus programs also continues to grow at record levels. Between 2000 and 2015, enrollment in U.S. undergraduate degree programs increased by 30%. By 2026, that number is expected to increase to 19.3 million.
The average college can only provide on-campus housing for roughly 25% of their students. Just last month San Jose State University (SJSU) notified approximately 1,400 students that there would not be enough on-campus housing to accommodate them. Half of the students notified were incoming freshman.
“It’s frustrating as a parent to see my daughter going through all the motions of not having the college experience that she has been looking forward to,” said one mother from Solano County whose daughter selected SJSU as her top choice school.
University officials say the lack of on-campus housing is rare, and is a result of unexpectedly high enrollment. More than 5,000 freshmen are slated to arrive on campus this fall, a staggering 25 percent higher than the school anticipated.
Despite the uptick in student housing development, there is simply not enough new housing being built to accommodate demand—which makes student housing an attractive investment opportunity for the foreseeable future. Furthermore, when the economy dips, demand for student housing typically increases as more people decide to go back to school.
Student Housing Considerations
To be sure, student housing investing is not foolproof. Many of the tenants in student housing are renting an apartment for their first time and often won’t be able to provide the credit reports or landlord references typically requested when renting traditional multifamily apartments. As a result, landlords are often managing leases with a student’s parents along with the student. This can make a transaction more financially secure, but can create additional headaches for landlords and property management companies.
Other key student housing considerations:
- Proximity to campus is important. Most investors strive to be within a quarter- to half-mile walking distance to campus.
- Units should be in turnkey condition and tailored to the needs of university students. “One challenge for folks who are not intimate with the student housing market is that it is more than just sticks and bricks,” says Bill Bayless, CEO of American Campus Communities. “You have to create properties that are conducive to academic achievement and that fit the culture of the university. People from the apartment sector who come in and build a standard floor plan may find that the product may not fit.”
- Property management is crucial. Student housing is management intensive. It can be hard to find tenants in the off-season (usually May through August), and investors have to brace for the reality that students can cause excessive wear and tear relative to experienced renters.
Despite the industry’s challenges, investors are starting to see how lucrative the sector can be. Student housing has become its own niche, no longer stepchild forgotten sub-asset-class of the multifamily industry.