Bricks and mortar boards
As REITs gain ground across Europe, professional advisers and the property industry have been exploring the opportunities that these new property vehicles will present for investors and organisations with large property portfolios. Of particular interest to potential investors could be the large and varied property portfolios of universities and higher education colleges, which range from halls of residence to specialist laboratories, sports facilities to libraries. Investments in these properties would also allow the educational institutions to benefit from cash injections to enable further development and allow their focus on core activities.
A recent seminar hosted by law firm Martineau Johnson and corporate administration specialist Ogier focused on the benefits of REITs in the education sector. Brian Lee, the CEO of Ogier in the UK believes that the REIT potential is huge and in particular will be of great interest to pension funds.
Furthermore, student accommodation REITs might be a very attractive proposition indeed, with a portfolio comprising residential property assets where the rent is paid in advance three times a year, where there should be excellent leverage through good tenant behaviour and where the tenant population renews on an annual basis. All of this points to reliable and predictable revenue stream from residential property for investors and this predictability should carry its own premium in the market.
What is in it for the universities?
Universities and colleges have conflicting pressures on them. Their core business is in the provision of education, but time and resources are spent in administering their property portfolios. They also have to manage the demands for further investment in quality student accommodation and ever more advanced teaching and research facilities to maintain student numbers. Releasing all or some of their property might produce the capital required for further development.
Student hall accommodation should provide a predictable rental income with an annually renewing tenant population as well as a property estate which can be managed efficiently. In the UK, for example, there were approximately 1.75m graduates in the year 2004/05.
The UK government has a target of 50% of all 18 to 30-year-olds in higher education. The current level is 43.5% and 26% of students want to do post-graduate courses (UK Graduates Careers Survey 2004). The sector would seem to have growth potential on top of yields averaging around 5.5% to judge from some recent deals. In November 2004, Morley acquired 1,246 beds from UK-based student accommodation operator UNITE for £49.4m (€73.6m) at a yield of 5.8%, October 2005; in October 2005, operator Liberty Living bought 1,386 beds from student accommodation funding, development and operating company UPP for £57.3m at a yield of 6% (£41.3k per bed); and last December, Cordea Savills bought 1,581 beds from UNITE for £64.1m at a yield of 5.22% (£41k per bed).
To date less than 7% of halls of residence are in the hands of private operators. While universities and colleges still view it as important to provide the undergraduate experience, the inflexibility of negotiating 25-year term debt and the complexity of PFI finance should mean that REITs represent an attractive funding vehicle for the higher education (HE) sector.
The HM Treasury (the UK finance ministry) and HMRC (the UK tax and customs authorities) have confirmed to us that, as regards the 40% rule, halls of residence should qualify as a number of properties rather than one single property. Accommodation units need only be capable of being rented separately and there is no requirement that they need to be fully self contained.
The same point applies to incubator units (university-funded administration research units) if the individual units are capable of separate rental even though there are common parts. What other properties might be included?
Well, potentially shops providing facilities to universities and gymnasiums, but also much larger properties such as lecture theatres, administration blocks and libraries which are then let back to the university or college.
Provided no single property exceeds 40% of the portfolio, there is the potential for very substantial parts of the real estate used by universities and colleges to be refinanced through a REIT. And overseas properties might also be included.
PFI finance is in shorter supply because lending institutions do not want to take a long-term view on the prospects of a higher education institution. With an investment in a REIT, should an investor’s view about prospects deteriorate, then the investor would not be locked in with the investment but would be able to dispose of it in the stock market.
Alternatively, if the real estate of a university or college were to be owned and financed through a separate REIT vehicle, this would undoubtedly represent a very significant reduction in or a complete elimination of borrowing risk for the higher education institutions themselves.
Any estate interest or right in land can be used to provide the basis for the REIT property rental business and thus a critical structuring issue for a higher education institution REIT willing to explore these new waters, is whether a university or college should sell its land to a REIT or whether it should instead grant a long lease or possibly a short lease.
If a principal objective were to realise a capital sum by a sale
of its estate, then a university or college might succeed in negotiating the best price from investors otherwise denied the opportunity of investing their pension monies directly in
Capital realisation might not be the sole nor the only objective and a university or college might equally wish to value a property transfer to a REIT on the basis of reduced student rents being put in place, thus making it more competitive in the market for students.
Many UK universities will recall the BESCO schemes which were used several years ago; five-year deals which enabled universities to arbitrage the tax reliefs then available under the business expansion scheme.
Could a lease as short as five years be granted to a REIT? If a company remains within the REIT regime for a period of less than 10 years (and, once in, a REIT does have the option of leaving voluntarily but may also be expelled by HMRC for breach of the qualifying conditions) then HMRC has the power to counteract tax advantages enjoyed by the REIT while it was within the regime.
There is as yet little guidance on how the early exit rules will be applied but for the moment it might be prudent to assume that REITs and property deals with REITs are likely to have a minimum life of 10 years.
If the university or college effects an outright transfer of property to a REIT is it selling the family jewels? The answer to this that a sale doesn’t need to be beyond recall as it should certainly be possible to negotiate a right of pre-emption should the REIT ever want to sell on the property. As regards day to day control a university or college will no doubt be also keen to negotiate a management contract for its estate management office. This would have the added advantage of creating a new income stream.