The growth in the purpose-built student accommodation (PBSA) market, especially in the UK, has largely been as a response to meet the demand of an increasing student demographic. This has been the case for both domestic and international populations.
In the early 2000s provision of student housing was largely delivered through university affiliated institutions, however, the dynamics of the market have now changed considerably. Altered demand in the market resulted in a shift in provider mix, with private sector halls increasing their provision by 45% from 2014 to 2021 (HESA, 2022). The increasing size of this sector has led to the development of a distinct real estate asset class which has enjoyed consistent appetite amongst investors partly driven by an increased demand to identify opportunities in non-traditional sectors to improve diversification (McIntosh et al., 2017). One of the latest transactions has been the Singapore Sovereign Wealth Fund’s £3bn acquisition of Student Roost, previously owned by Brookfield.
In structured credit there have been a couple of UK student housing backed CMBS transactions in recent years, with issuance sizes being £232m and £250m. These deals were backed by Brookfield’s Student Roost portfolio and Blackstone’s IQ portfolio respectively. A deal sized at £375m backed by £751m of assets was recently brought to market in May 2022 but was later pulled given adverse market conditions. With the increasing relevance of PBSA, a holistic evaluation should be conducted to identify if such assets provide an attractive investment. Of particular note would be to identify characteristics which make these assets attractive, but also risk factors facing the industry.
Figure 1: UCAS Accepted Applications. Source: UCAS
Factors explaining risk premia between PBSA assets
When considering deals across the CMBS universe it is crucial to identify the risk factors which define the underlying assets of the securitisation. In relation to PBSA, one specific characteristic of this asset class compared to other real estate classes is that there is only marginal stratification in build out. That is to say that new build PBSA are relatively more homogenous in their design and structure in contrast to other real estate asset classes. This, therefore, points to higher weightings on other risk factors to explain the risk premium between assets. If running a hypothetical asset pricing model on PBSA assets, I would hypothesise that two key factors explain the differences in expected returns: the quality of educational institution associated with the core student base and locality to such an institution.
Figure 2: Percentage Change in Student Numbers by each individual university, sorted by rankings (Complete University Guide, 2022). Shows the percentage difference between 2014 and 2021 student levels (Higher Education Student Numbers, 2022).
One way to infer how quality educational institutions have performed over a time horizon is to analyse the change in their student base. In an environment of increasing student numbers, it has not been the case that a rising tide has lifted all boats. Figure 2 shows the percentage change in student base sorted by ranking. Those ranked in the top 40 show a more consistent increase in student base, whereas those ranked below 40 exhibit a much higher degree of volatility, thus inferring a higher risk premium for PBSA reliant on such institutions. One reason for this trend is that higher quality education institutions have excess demand for university places, thus providing a strong foundation for demand. For CMBS deals, this ensures a greater degree of certainty around the cash stability of transactions.
Locality reflects more of a traditional real estate risk factor where prime locations can command higher rents. In the context of PBSA, a preferred locality is that closer to target universities as they will be able achieve greater pricing power and preferred referral contracts with such universities. However, there are particular nuances in the context on PBSA. Locality should also be thought of in terms of coverage to multiple university institutions which enables a degree of diversification, thus reducing possible concentration risk to an individual institution. Whilst there will be an array of further factors of consideration to explain the risk premium between PBSA assets, it is important to realise that if assets fall short on such factors mentioned, it can extend significant risk to the underlying cashflows and, thus credit risk on securitised transactions.
Figure 3: First year non-UK Domiciled students by domicile. Source: (HESA), 2022
Market wide risks factors
In respect to market wide risk factors, there exists specific challenges to the industry which require focus when evaluating potential opportunities. For one, there have been regulatory changes which have removed barriers to construction on student housing in order to meet excess demand (Sanderson and Ozogul, 2022). In such an environment, it is important to be aware of the possibility of oversupply in specific markets which may result in higher competition on pricing and reduced occupancy.
One nuance of this asset type is the dependency on international students which has recently experienced a substantial change in dynamics in the UK, including the possible impact of government restrictions on student flows, thus raising potential uncertainty. Of particular note is the rise of Chinese students enrolled at UK universities (Figure 3, HESA) which has historically contributed significantly to the robust demand of PBSA. Overall, Chinese student enrolment remained relatively robust over recent periods, however, the continued lockdown approach in China, with further tightening on what is classified as essential foreign travel, cannot be overlooked.
Another potential risk is that, in a post-Brexit UK, EU students are no longer charged fees equivalent to domestic students and are now charged substantially more, which has resulted in the number of EU students applying to UK universities dropping by 50% in 2021 (UCAS, 2022) and overall, the number of international applicants has dropped 5% in that time, though this has been largely offset by an increase in non-EU students, especially from India.
Other risks on the horizon include higher inflation, which is likely to impact the sector materially through increased operating cost and compressed margins. Therefore, considerations around hedging energy costs are of increased relevance when evaluating deals.
From a valuation perspective, baseline prime regional yields compressed towards 5% at the end of 2021, with prime yields in London standing at 3.5% (Savills, 2022). Given the rising interest rate environment and the widening out of yields across a multitude of assets classes, in order to justify current valuations, there would have to be a material increase in rents or assets could face potential downgrades in valuation.
Looking at the historical performance, the sector has shown robust fundamentals with strong demand driven by an increasing student demographic. From this has followed strong investor activity, highlighting the high level of interest in the sector. Taking a forward-looking approach, there are certain risks which need careful consideration, including the risk of over-supply, inflationary pressures and changing student dynamics, and from a wider context of a repricing of risk across a multitude of sectors, careful due-diligence will be required to identify appropriate deals and opportunities in the future.
by Alexander Young, Jr. Investment Analyst