Back to school
Student hall fund managers will tell you it’s a growth asset class offering a stable income stream and a credible alternative to residential because its investment characteristics - including yields and relatively low cyclicality - are closer to commercial.
“Especially in the UK, investors are scared by all things residential,” says Alison Puhar, fund director at Cordea Savills, whose student hall fund has 10 (unnamed) investors, “but this market is significantly larger than commercial”.
What they tend to be more reticent about is the high-touch management, questionable demographics and uncertain prognosis for the higher education sector. For it to profit investors longer term, student accommodation has to deliver in several areas. This is a punt on a market that is far from certain.
But take the drivers first. The exuberance that has developed among investors over the past 18 months reflects a market that Cordea estimates to be worth £15bn (€22bn).
But if it is so good, why did it take so long to emerge? First, there is the issue of demand.
Knight Frank’s 2006 Student Accommodation Review cites a growth of 500,000 in the UK student population in the decade to 2004 and a 2-5% increase in student rents in 2005. But the health warning on past performance bears repeating. Better mapping of demand trends (because of available data on the higher education population) does not equate to better demand trends.
The current glut of young people in the UK is expected to decline gradually after 2010. Leading student accommodation operator UNITE acknowledges that “there won’t be a smooth upward trend over the next few years” but pins its prognosis on a job market that demands a graduate-level education.
Even in its primary European market, despite an explicit government target to increase the UK’s graduate population to 50%, there is little to suggest this is much more than wishful thinking. “Many do not reach the destination, but it is likely that they will continue to try,” says UNITE spokeswoman Tabitha Birchall.
In any case, rising numbers of overseas students are meant to offset an apparent decline in domestic numbers.
Gardiner acknowledges that there are “lots of risks” with student halls - including the demographic one. “It’s quite simple. How many people are there in the age group? You could say we have peak demand. Even if UK students don’t make up the expected numbers, there are always overseas students. But these have more choice, too. They could go to Australia or Canada.
“Universities are competing for students. The top 30 will attract most applicants and have most choice,” he says. They will also attract most investors: Unite and Cordea Savills are both highly selective about the universities they invest in.
The more sophisticated fund manager analysts skirt away from universities likely to have significant populations of live-at-home - ie poor - students. “Status is important,” says Puhar. “If you choose universities that are in demand, the risks are lower. With some of the newer ones, where there is not as much value in the courses, students will travel from home or economise in other ways. That isn’t a threat with the right quality of university.”
Second is the issue of supply. In theory, universities will increasingly move out of the business of running student halls in a bid to generate cash. Cordea Savills’s March analysis of the sector, for instance, claimed residential would increasingly be provided as commercially operated communal establishments (COCEs), with national coverage offering economies of scale.
It is not just asset managers going back to college, either. Private equity group Blackstone’s £95m 16-floor Nido student housing development in London’s King’s Cross district, announced in September this year, is scheduled for completion in September 2007. With some mixed use, the three retail properties will front the block and commercial space will take up almost 20,000 sq ft (1,859 sq m).
The University Partnership Programme - which proved singularly resistant to being interviewed by IPE Real Estate - has ploughed £600m into the development since it was set up in 1997 and claims to have won £900m from institutional investors for new projects over the next five years. In September it announced that it would partner Loughborough University in a planning application for three on-campus student halls. Work on the project, scheduled to begin early next year, is likely to be completed in September 2008.
Yet this is still a small sector with a limited number of players (both Morley and Cordea Savills have acquired properties from Unite, which continues to run them and share profits).
While the market is still to play for, student accommodation might well continue to be an attractive prospect. Neil Gardiner, manager of the £32m Morley Beach Student Accommodation Fund, believes that the prevalence of commercially operated student halls will promote stock turnover and thereby increase investor appetite.
But it is already changing. “It’s a fragmented market,” says Brian Lee, CEO of the UK fiduciary business of Ogier. “Universities are under [financial] pressure. It’s a good combination of factors but, as the market matures, property managers and agents will enter it.”
Supply is an issue in London, although international property consultant King Sturge predicts an increase in the number of short-term agreements between universities and developers - universities because they would avoid being locked into long-term rental obligations and developers because they could raise rents in future.
While it would probably make sense for universities to enter into these agreements it does not necessarily mean that they will. In any case, Puhar identifies as a threat to student accommodation a significant increase in the pipeline of accommodation. “It’s already increasing, though it isn’t yet a problem because many universities are growing as quickly as the pipeline.”
In the meantime, the two options for universities are to acquire them through the private sector or to go into partnership. “As the market has risen, the stock hasn’t,” says Gardiner. “So you have yield shifts, and some investors are looking abroad.”
A very British asset class
As an asset class, student halls are geographically limited. Not that investment in student accommodation is a UK-specific phenomenon but - at least within Europe - the UK has been its primary market. The trend began in the US and it is clearly taking off in the UK. But that does not mean it is possible to extrapolate from the UK to mainland European markets.
One of the factors that makes student accommodation a punt for institutional investors is its market specificity. Because the prognosis for the asset class is based to a large extent on demographic trends, as well as policy shifts, this is not an asset class that crosses borders particularly easily. Extrapolating from the US, where institutional investors have long embraced student halls, will not help.
According to Gardiner, “50% of the market is in the UK. It’s like healthcare: you have to take into account how people live, how they’re educated, whether there’s a strong market.
“Look at Madrid. It has a massive student population but whether those students would want to live in purpose-built student halls, I’m not sure. The same is true of Germany and France. It has to produce a yield at least the same as in the UK,” he adds.
Pension funds, where art thou?
As an asset class the university accommodation is, reportedly, attracting institutional investors by the barrelful but in reality much of the exuberance seems to be coming from fund managers rather than pension funds. Significantly, those pension funds canvassed by IPE Real Estate downplayed the attractiveness of the asset class, instead focusing on the specific, niche function it performed in their funds. Wirral Council pension fund, for instance, which in February 2006 invested more than £5m in Cordea Savills’ student hall fund, says it did so to gain exposure to residential in large lots.
John Parry, investment manager at the pension fund, said the rationale for investing was the paucity of UK residential lots of sufficient size to be of interest.
“We’re looking for large lots - £10m at a time - and there just aren’t that many of them,” says Parry. With a portfolio of £360m, comprising more than 30 properties, it represents just under 1% of the real estate allocation.
“It’s diversification, simply,” he says, “and this was one way of investing in it. We have no current plans to invest more.
“We’d look for opportunities where we can, and we’re looking to diversify across the fund. Within real estate, we try to have industrial, retail and commercial - the common spectrum. But we don’t really have residential because it doesn’t come in the lot sizes we’re looking for. That’s why we looked at student accommodation.”
ABP, which owns more than 4% of UNITE does not comment on the companies it invests in. A spokesman had to check to see if it owned any student halls at all. Eventually, he pointed out that it was an equity, rather than a real estate, investment.
The market is changing because so too are the contours of demand. Birchall acknowledges that UNITE is flirting with hospitality rather than residential, including the appointment in September of former Hilton European vice-president Tony Harris as chief financial officer in its efforts to rebrand itself as a “student hospitality” company.
So what exactly is the asset class? “Many of these are quasi-hotels - especially the cluster flats,” Gardiner says. “They have a hotel feel but they’re residential.”
Puhar agrees there’s an element of hospitality involved. “The best-run blocks don’t see their tenants as students. They see them as clients,” she says. “We’re seeing demand from UK and foreign students, and they find the idea of paying more for premium accommodation acceptable.’
Even if the UK government’s 50% undergraduate target transpires, it doesn’t automatically create a market for student halls. These don’t just have to be undergraduates; they have to be undergraduates with the means to pay for (premium) accommodation.
Funds are pitching premium, transforming the sub-sector into one more akin to hospitality than to fleapit hovels that could otherwise serve as sets for La Bohème. The obvious risk is that students won’t be able to pay for it.
“There’s the cost of being a student,” says Gardiner. “The lack of grants and the [high] tuition fees; the fact that students leave university in debt mean that living at home might be more cost-effective. Being a student can be expensive, and [in all markets] you need to look at where students are getting their money from.”
What a difference a REIT makes
The title of a seminar delivered at the London Stock Exchange in July described student accommodation REITs as “a niche opportunity”, and that is precisely what they are.
Knight Frank believes that the introduction of REITs will accelerate the sector’s maturation process. The tax advantages of becoming a REIT are clear enough, but most residential companies are private. “There’s a question about the extent to which smaller companies will be able to go through the cost and hassle of listing,” says Andrew Panting, a spokesman for the British Property Federation (BPF). “The companies that are open about converting - British Land and Land Securities, for instance - are large. If the majority of your turnover comes from rental income, you can’t readily convert.”
BPF plans to lobby for extension to non-listed and AIM-listed companies but, even so, it isn’t clear that this will provide a significant fillip to student accommodation as an asset class.
“Will REITS boost the sector? It’s difficult to say,” says BPF financial director Gareth Lewis. “The way the market will develop initially will probably be with [already listed] property plcs, with a few new REITs in 2007. In terms of residential, there won’t be much going on because most of the companies are private. The same goes for student accommodation. The bulk will be commercial property, although the government wants residential to be in there.
“Still, the market may find a way of getting around it. If there’s demand, they’ll get around it.”