What is the economic outlook for the year, and what does that mean for the student housing industry? Hessam Nadji, president and CEO of Marcus & Millichap/Institutional Property Advisors, answered just that in the keynote speech that kicked off the 2019 InterFace Student Housing Conference, which was held in Austin earlier this month and drew approximately 1,400 attendees.
Nadji began by laying out the basics on where the industry is today economically in comparison to before and during The Great Recession.
“We’ve added 21 million jobs since the bottom of The Great Recession, and that has caused a 120 basis point reduction in the unemployment rate at a time when inflation is 200 basis points below where we were in 2007,” he says. “That is the crux of why everything in our industry as a whole — commercial real estate, and student housing in particular — has done so well. The combination of really good growth with very little inflation, and therefore low interest rates.
“We have 7.6 million job openings today,” continues Nadji. “That is a record number of employers looking for qualified employees and about one-third of those employers are having a hard time finding qualified workers. That is one of the obstacles to growth. Our GDP has grown by $6.2 trillion, twice the United Kingdom’s total economic output in the last 10 years. We’ve also had a 160 point reduction in the interest rate while all of this has occurred.”
On top of this, we have a significant movement of demographics currently underway. “Today, 10,000 people in our country will turn 65 and enter that segment of the population.” says Nadji. “What makes us very unique is that we are the only developed economy in the world that has right behind it 12,000 people per-day turning 21. Think about that dual demographic, seismic movement of people and what it means to different consumption, occupation, space and real estate needs and preferences. The world is changing extremely quickly as we speak.”
In summary of all of these factors, Nadji notes that you could not ask for a better basic economic and demographic environment in the U.S., which poses the question — why all of the doom and gloom and negative headlines?
“One of the answers is in the yield curve, which is the spread between short term and long term interest rates,” answers Nadji. “Our yield curve has been on the down slope for the past year or so as the Fed has had to raise interest rates to fight off inflation build-up. More global and domestic concerns have also brought long-term rates down.”
Is this an indication of an immediate problem? Nadji’s answer, in short, is no — we do not need to be expecting a downturn right around the corner. “I really do not see that as the case,” he says. “Consumers in America are spending 17 percent more today than the total in 2007 — this is inflation adjusted. Retail spending is 17 percent higher than when we were refinancing homes on average twice a year and all of that cash windfall was coming in a totally unsustainable fashion that was not fundamentals driven. Today’s spending is much more fundamentals driven and it’s 17 percent higher than it was at the prior peak.”
Corporate profits and investments are also at a record level. “Companies have stayed very conservative in the expansion,” Nadji says. “They hoarded cash, they didn’t get over their skis and investment — which is a very important indication of economic growth — got a boost from tax reform and is staying in the 5 to 6 percent year-over-year growth range. That is a really healthy degree of corporate investment.”
Where most economic expansions last five to six years, we are in year eight, according to Nadji. “Yes, we’re overdue,” he says. “But why is it that we’re not right about to hit a major downturn? It can be explained by the pace of job creation — this is what I mean by job growth and economic prosperity with very little inflation. That has left a lot of flexibility for the Fed to have an elongated period of accommodation for the U.S. economy.”
Nadji’s largest concern for the coming year? Global trade. “All that has happened in terms of trade and tariff wars is very important to us,” he says. “Almost 14 percent of our economic output is from exports — they are extremely important to this country. The wars that we experienced last year with some of our trading partners and the ones that are still lingering with China have effected a lot of our industries. If it were to get out of hand, this could be a huge problem and more of a systemic risk than a cyclical recession of any kind.”
Student housing outlook
So what does this mean for the commercial real estate industry, and specifically, the student housing sector? “For us in commercial real estate today, the ultimate test is the spread between interest rates and cap rates,” says Nadji. “Because we haven’t overbuilt in this cycle and because we haven’t over-leveraged as we had between 2006 and 2008, the stability of this industry is creating a relatively stable spread.”
“As for student housing, what is going to be the transformative effect on those job openings that I mentioned earlier where employers are having trouble finding qualified workers? Higher education,” Nadji continues. “There is a skill gap in America between what companies need and want and what is available in the educated workforce which can only be fixed through more students attending universities.”
Student housing has been capturing capital as an alternative investment and now as a proven and well-established industry with trading volumes north of $10 billion last year, he notes. “Student housing is truly outstanding in its ability to capture institutional and foreign investment,” Nadji says.
“From a cap rate perspective, there is a recession-resistance to this sector — during downturns, people still go to school,” Nadji continues. “The industry was recognized and rewarded for that, and today, even with the compression, there is still a cap rate spread to apartments, creating a favored status. Unlike apartments where development equity has gotten very cautious, student housing is looking at three different channels of capital that are still aggressively pursuing opportunities — whether it’s ground-up development, core investments or value-add. There is no shortage of capital demand wanting to participate in the sector.”
“What’s really important is the supply side of the student housing ledger at an overall level for the country,” Nadji says. “As a percent of total stock, construction has already pulled back into a pretty healthy, sustainable balance. In summary, this industry is at the crux of benefitting from solid fundamentals and operational NOIs. Oversupply concerns are very submarket specific. Institutional acceptance is also a huge part of why we are where we are today and where we are going in student housing.”
“Expanding foreign enrollments, Baby Boomer parents allowing their children to stay in school longer, the youth population wanting to be around university and urban areas and the urbanization of America is part of the lift into our industry,” Nadji continues. “Risk-adjusted yield spreads are still very attractive. The question is what is your X factor? It seems to be the perceived value of product differentiation, changing amenities and design. That might be the X factor to focus on more than anything else.”
— Katie Sloan
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