Is Student Housing a Tale of Two Markets?
By Les Shaver
Campus enrollment decline and overdevelopment fears are hurting student housing as capital sources pull back and lenders grow cautious.
When Freddie Mac and Fannie Mae slowed multifamily lending in the late summer and early in the fall, the repercussions were felt throughout the rental housing sector.
But with rising defaults already an issue, the GSEs’ pullback hit the student market especially hard. “Lending is an issue in student [housing] right now and it is freezing the market,” says Ari Rosenblum, Co-Founder and CEO, Vie Management.
The pullback from Fannie Mae and Freddie Mac is only one issue slowing lending volume in student housing. With enrollments falling in some places and pockets of overdevelopment, occupancy is bound to soften. When that happens, some of the more aggressively financed student deals are running into trouble and going back to the banks.
But these issues aren’t universal. In strong markets with good schools, occupancy has held up and capital is still available. In the less desirable locations and assets, the story is different with buyers and capital spooked by occupancy concerns.
Stepping into Trouble
Last fall, Trepp’s Manus Clancy and Catherine Liu reported that there was nearly $4.5 billion in private-label CMBS student housing debt across 250 loans that were outstanding, which represented more than 11 percent of the total multifamily balance. As of August, approximately $331 million in student housing loans were delinquent. Almost all of these problematic loans were issued in 2010 or later.
“The student housing delinquency rate of 7.36 percent is far above the post-crisis level for any major [commercial] property category, including the much-scrutinized retail sector, which has attracted much of the industry’s concern,” Clancy and Liu write.
Another $123.3 million in loans were current but with the special servicer. In all, $1.53 billion worth of student housing loans were made on properties constructed in 2010 or later, according to Trepp. Some of those communities are now in trouble as they’re having difficulty maintaining occupancy levels and strong rents as they face new competition.
“The housing options that find it hardest to compete are those complexes that were amenity-rich 10 years ago and remain pricey, but now seem dated,” Clancy and Liu wrote.
As the slow-moving glacier of student housing debt continued to grow over the summer, the GSEs backed off of lending, which brought transactions to a virtual standstill.
“Agencies lent significant amounts early in the year that reduced the amount that they had left to lend in the third and fourth quarters,” says Brent Little, President of Fountain Residential Partners. “Rather than not quote [offer] permanent debt, they raised the rate to reduce volume. This affected proceeds and hence volume.”
The Federal Housing Finance Agency gave the GSEs 2020 lending caps, which freed them to provide debt. But things aren’t back to normal in student housing.
“The agencies have always played a pretty good role in student housing, but if they look at their portfolios, which are near pristine, the few issues that they have tend to be in the student housing area,” says Brian Stoffers, Global President, Debt and Structured Finance for CBRE. “So as a result, they’re getting more scrutiny and being more conservative.”
Rosenblum also sees more caution from agencies. “When lenders start to act more conservatively, student and specialty housing are the niches that feel it first,” he says. “There is not much going on [from a transactional perspective] in our space right now.”
Fortunately, there are some other debt options emerging for certain segments of the market. “Some borrowers are looking at life companies and CMBS,” Little says.
There has an also been a proliferation of new debt vehicles across the entire commercial real estate space, which is giving student housing buyers some options. While these loans provide advantages, they could also come with strings, such as full recourse.
“A lot of debt funds are priced pretty competitively at this point,” says Eric Frank, Chief Investment Officer, Cardinal Group Cos. “They used to be really expensive but the debt funds are not outrageously expensive.”
On the equity side, there is money recapitalizing existing owners. “The developers are recapping their deals and trying to hang on,” Frank says.
At the heart of the uneven student debt market is a supply-and-demand issue, at least in some markets. Overbuilding in the sector at the big Southeast Conference schools and other large universities has long been a concern.
On-campus deliveries are becoming a concern. RealPage tracks 175 major universities and in 2020, those schools are set to deliver more than 35,000 new on-campus beds. Annual supply hasn’t been this high on campus since 2001.
“Student housing has become somewhat overbuilt in certain areas,” Stoffers says. “The occupancy levels have suffered in some markets. So, there is a little softness in pockets.”
Stoffers isn’t the only capital provider with that opinion. “I think people are starting to be very cautious on student housing,” says Gerard Sansosti, Executive Managing Director and Debt and Loan Sales Platform Leader for HFF. “I've heard that a high percentage of CMBS 2.0 defaults have been in student housing, which makes sense because of how much has been built. So, I think you're going to see people take their foot off the gas a little bit there.”
While capital providers point to supply issues with overbuilding, there could also be demand concerns. Now that the huge millennial cohort has funneled through the student sector, some colleges and universities could struggle with lower enrollments going forward.
In December, the National Student Clearinghouse Research Center reported that postsecondary enrollments decreased 1.3 percent, or more than 231,000 students from the previous fall to 17.9 million students. The report covers 97 percent of enrollments at degree-granting, post-secondary institutions eligible to receive federal financial aid. In the spring, enrollments fell 1.7 percent, or roughly 300,000 students. Last year’s decline was 1.8 percent. This is the eighth straight year that enrollments have declined.
“It’s kind of a tricky moment in time where there is a demographic movement where we’re kind of between generations,” Frank says. “We’ve peaked out on the millennials, and then Gen Z picks up in the next two to three years.”
Still, the quality schools should withstand any shock from declining enrollments. In fact, nearly two-thirds of U.S. college students go to schools where enrollment has been consistent in recent years, despite some significant adverse conditions, according to Doug Shapiro, Executive Research Director at the National Student Clearinghouse.
David Adelman, CEO of Campus Apartments in Philadelphia, describes the enrollment situation as “flattening in some places.”
Overall, many developers and industry experts remain cautiously optimistic that buildings becoming available will be filled despite declining enrollment. The prime reason is that enrollment declines aren't universal. It’s mostly at for-profit, four-year universities and community colleges rather than nonprofit schools, except for some struggling small nonprofits.
“If you own a portfolio of 30,000 to 60,000 beds, then these macro numbers may have a slightly negative effect on your portfolio,” Little says. “Most do not, so what matters is the quality of your asset, your location, how you manage the property and your resultant NOI [net operating income] and ROC [return on cost]. The rest is just noise.”
Though smaller, there has been a noticeable drop off in international students. The total number of international students enrolled in U.S. colleges fell by 2.1 percent from fall 2017 to fall 2018, according to the 2019 Open Doors Report on International Education released by the Institute of International Education and the U.S. Department of State's Bureau of Educational and Cultural Affairs.
“You’re starting to see some stuff come out about the huge drop in international enrollment,” Frank says. “A lot of the schools that everyone thought of as these rock-solid schools that always tend to grow relied on growth that was coming from international student enrollment, and that’s really fallen down.”
Again, Little doesn’t see this as an issue. “Pick any school and see how many they qualify as international students,” he says. “In most schools, this is a few hundred. Losing less than 50 percent of these is not moving the needle.”
Winners and Losers
If money is looking for student housing, Frank says you can find it in two places—the bottom and very top of the market. He says a lot of the capital in the student market either wants distressed assets (and the much higher returns they can provide) or high-quality assets in good markets with good fundamentals.
“If you go to some of the stronger markets—and there aren’t a ton of really strong markets right now in student—you’re seeing a lot of situations where everyone wants the good assets in good locations,” Frank says. “Everyone who is out there is after the same deal. It’s kind of a game of winners and losers these days, where certain assets that have the right profile are seeing a lot of activity and those that don’t are seeing no activity.”
For the most part, capital wants larger schools, according to Frank. “I think the real challenge comes with these small secondary schools—where the enrollment hasn’t grown in a long time or maybe it’s even shrinking. I think that’s where the agencies have really pulled back and that’s where the story is a lot harder to make sense of,” he says. “There’s a lot of concern over the long-term liquidity at some of those smaller markets.”
The trend of the big getting stronger is something that is happening across the economy, according to Rosenblum. “Like every other industry across the globe right now, what we are seeing with universities in the U.S. is that the larger, institutional universities are the winners and smaller and more regional colleges are the losers,” he says. “The big are getting much bigger and the small to mid-size colleges are suffering. This is true as it relates to enrollment, endowments, and state and local support. Enrollment is not going down overall, but at smaller, less well-known schools, it certainly is.”
Part of the reason for the emergence of larger schools is that students are revaluating the cost of their college education. Rosenblum sees many students now evaluating if they are getting what they’re paying for with respect to their educational investment.
“With the large Tier 1 schools the answer is generally yes, because, among many other reasons, there is a network of successful alumni that will help them get a higher paying job as a postgraduate,” says Rosenblum, who focuses on Tier 1 schools and student housing in urban cores. “With smaller or more regional colleges, people are not seeing the same benefit when they go out into the job market, but they are saddled with the same amount of debt.”
Adelman agrees with this take. “Students and parents are selective and want to make sure there is a value proposition to the school they choose,” he says.
Despite potential enrollment problems at smaller schools, there are high net worth individual and family offices that play in the smaller markets and are still very interested in those areas, according to Little. “The issue is big projects in secondary or tertiary markets,” he says. “You need to right size the project to the market. You have developers building 700 to 800 bed projects in markets of 10,000 to 15,000 FTUG [first time undergraduate]. They are just too big, and the capture ratio is too high.”
Frank says there is a concern among buyers that even if they can get an agency loan to purchase a student community in a less desirable market, they may not be able to sell it down the road.
“You are potentially walking into a situation where even if you bought it [a student housing community] for a six-and-a-half cap [rate], the next guy may have to get a seven-and-a-half cap just to hit the same return,” Frank says.
Those concerns have led to a stalemate between buyers and sellers. “There’s just a big gap between buyer and seller expectations,” Frank says. “In real estate, that tends to be the best indication of a change in pricing as a drop-off in transaction volume. On the way down, people are sticky on pricing where they don’t want to sell it. But as these loans come due, that’ll be the catalyst to start to force people to sell.”
Little also saw buyer apprehension in late 2019 but says brighter days are ahead. “We have heard anecdotally that some buyers are pulling their horns in a bit and being careful not to overcommit,” he says.
But he thinks that situation could change into 2020. “I expect the first quarter to be back to business as usual,” Little says. “Remember, these funds still have hundreds of millions of dollars to place every year, and the banks don’t make money not lending.”
Barbara Ballinger contributed to this article.