Student housing’s strong occupancy rates and rent growth stand out as a bright spot when compared with the rest of commercial real estate sectors, many of which turned in a lackluster performance over the past year. Student housing rental rates at the nation’s top 175 universities increased an average of nearly 8 percent in the 2022-2023 academic year while occupancy in the fall of 2023 was 150 basis points higher than the average occupancy rate over the five preceding falls, according to Berkadia’s 2023 Student Housing Pipeline Report.
Pre-leasing heading into the 2024-2025 academic year surpassed 40 percent in December, according to RealPage, and observers expect effective rents to increase an average of around 10 percent compared to around 9 percent in the 2023-2024 period. Meanwhile, fewer lenders are willing to provide construction financing, which is slowing the development pipeline. Developers could add 48,000 beds in 2024, an increase of 11 percent over 2023, but new supply is projected to decline steeply to 28,190 beds in 2025, Berkadia reports. Those metrics, along with growing enrollment at many top universities, are fueling student housing investment demand.
The problem, of course, is that student housing faces the same challenges as other property categories — namely, a bid-ask spread fueled by the debt environment that is thwarting investment sales. Involuntary sellers, such as disputing partners, funds coming to the end of their investment period, and owners facing near-term maturities without a path to refinancing absent a capital injection, are driving much of the activity. Buyers are also hunting for deals in which they can assume debt with interest rates in the 4 to 5 percent range, or lower.
“It’s a weird time right now in student housing because all the investment criteria are as good as they have ever been, but the transaction volume is also as low as it has ever been,” says Sean Lyons, founding partner of Triad Real Estate Partners, a student housing and multifamily brokerage based in Chicago. “It has nothing to do with the sector itself and everything to do with the macro environment.”
Student housing buyers and sellers consummated some $4.8 billion in deals in 2023, according to CBRE. That was about half of the volume in 2022, not counting Blackstone’s $13 billion acquisition of American Campus Communities, points out Jaclyn Fitts, executive vice president with CBRE and co-leader of the brokerage’s National Student Housing team.
Still, student housing investment sales didn’t fall off as much as multifamily sales volume, which recorded a year-over-year decline of 61 percent in 2023, reports MSCI Real Assets. Additionally, capitalization rates for core student housing assets range from 5.5 percent to 5.75 percent, which is slightly higher than multifamily cap rates, Fitts says. Historically, student housing cap rates have been somewhat elevated compared to multifamily, typically due to higher financing costs to offset the risks associated with annual lease-up schedules.
Student housing internal rates of return are also trending higher than multifamily on anticipated rent growth, Fitts adds. And, unlike multifamily investors now facing distress after executing negative leverage deals just before interest rates and expenses spiked (and rent growth slowed), student housing’s healthy occupancy rate gains and rent growth might bail out investors that may have overpaid for assets a few years ago.
“A lot of buyers have come off the sidelines and are really interested in acquiring student housing because of the great fundamentals,” Fitts states. “But sellers are a little more hesitant and want to have a better indication that the pricing is going to get better based on what happens with interest rates. And we’re not there yet.”
New Year, New Market?
Student housing brokers and investors are optimistic that 2024 will be a year in which the capital markets embark on a return to normalcy, especially in the second half of the year. The Federal Reserve’s pause in federal funds rate hikes last fall for the first time in about 18 months delivered a message that interest rates could begin to stabilize, Lyons says.
Additionally, comments from Fed Chair Jerome Powell in December suggesting that rate cutting would begin this year “acted as a tremendous springboard for the start of 2024,” acknowledges Austin Repetto, a principal with student housing and multifamily brokerage TSB Realty in Paoli, Pennsylvania.
But the question remains as to when exactly the Fed begins cutting. While there was hope late last year that rate cuts might begin as early as March, those expectations have been tempered. In January, the Fed indicated that it may be done raising interest rates but that it still considered inflation too high to make easing plans anytime soon.
Market odds for a March rate cut plummeted from 65 percent just prior to the Fed announcement to 30 percent after those remarks. Surveys conducted by CME Group, a derivatives marketplace, still indicate that the market anticipates rate cuts totaling 75 to 100 basis points in 2024. Uncertainty over a potential cut hasn’t impacted demand, Repetto says.
“Even if the interest rate cuts are delayed slightly, it’s not dampening the enthusiasm among investors focused on student housing,” he adds. “We’re working on numerous portfolios and individual properties for disposition in the first half of the year, and based on our initial discussions with buyers, we’re seeing the type of voracious appetite for acquisitions that we haven’t seen since the first half of 2022.”
Investors such as alternative investment funds and foreign capital who are looking to make their first purchases in the space are ratcheting demand up even further, say Fitts and Lyons. While some of those investors could bid for deals more aggressively just to get a foothold in the space, the lack of supply will remain a challenge, they add.
Ultimately, the wildcard of the presidential election this year could influence interest rate and broader economic policy decisions, remarks Andrew Stark, a founding principal of Timberline Real Estate Ventures, an investor in student housing, multifamily and mixed-use communities.
“The student housing sector is thriving, so there has been continued interest by investors to come into the sector and by existing owners to expand their footprints,” says Stark, whose Rye, New York-based firm has made $2.8 billion in investments since 2012. “But I believe that what happens with interest rates between March and July is going to be critically important to how we end the year.”
Value-Add Focus
From a transaction standpoint, Timberline’s activity in 2023 was on par with other years, Stark says. But pricey core deals have fallen from favor given the tough debt environment and the fact that merchant builders have largely been able to avoid selling by leveraging strong rent growth and occupancy.
Consequently, Timberline has shifted its focus from large-scale core opportunities to smaller value-add deals, especially those with assumable debt at 200 to 300 basis points below today’s costs of capital and that can be refinanced when the capital markets are more stable. “We’re not the exception to the rule (on such deals),” he adds, “but we seized on it early in 2023.”
Timberline also sold a major asset last year at a higher cap rate that it had hoped, Stark says. Still, the property had performed well, and it was a positive execution, he notes.
That’s a scenario that observers believe will play out more frequently this year. Last year could have been known as the year of the unrequited broker opinion of value. Potential sellers fervidly solicited the appraisals — Lyons’ Triad Partners performed 175 BOVs on student housing and multifamily properties — but owners were typically disappointed with estimated values well below their expectations and decided not to sell.
Experts say some of those sellers will decide to transact this year. The good news for many is that they can still turn a profit, says Andy Feinour, president and CEO of Student Quarters, an Atlanta-based owner of roughly 14,000 student housing beds.
“Maybe it’s not the return they underwrote, but they can still get capital out with a small profit and invest it somewhere else,” declares Feinour, who founded Student Quarters in 2013. “And if they’re a diversified owner, they can’t sell office or hospitality because they’re probably upside down on those properties.”
Student Quarters recently raised a fund and would like to add some 3,000 to 5,000 beds in 2024, says Feinour, who declined to reveal the size of the war chest. Until more voluntary sellers move off the sidelines, however, expect involuntary-seller transactions to drive the market, he and others add.
That’s only going to change when the capital environment does. Interest rates of between 6 percent and 7 percent are 200 to 300 basis points higher than they were two years ago, and as a result, more cautious lenders have generally constricted the amount of loan proceeds to roughly 55 percent of asset value, which is down from the more traditional 65 percent. What’s more, the spread over the benchmark interest rate that lenders are charging for debt is wider than in the past because fewer transactions mean less competition in the market.
“Interest rates went up very fast, and lenders are still very cautious,” Feinour observes. “As a seller, if you’re getting good net operating income (NOI), you’d rather wait for an improvement in cap rates and for banks to start offering better leverage, tighter spreads and lower interest rates.”
Holding Pattern
As an investor that aims to recycle assets though a few dispositions and about twice as many acquisitions each year, Tailwind Group is taking the same approach. The Mankato, Minnesota-based investor owns or manages a little more than 15,000 beds and would like to add between 2,000 and 3,000 more in 2024.
“A lot of people, including us, are in a holding pattern on dispositions because occupancies are high and we’re getting double-digit rent growth on a lot of our assets right now,” states Brandon Smith, vice president of operations for Tailwind. “So why would we sell at a discount when the outlook for occupancy and revenues continues to be so positive?”
In terms of acquisitions, Tailwind has sought out value-add opportunities with involuntary sellers — or at least those with motivations other than pure profit-taking. Last year, it placed the winning bid for The Sterling, a 20-year-old, 340-bed bank-owned asset at Louisiana State University in Baton Rouge. It also purchased the last two assets of a fund that was winding down, Smith adds. The company is pursuing significant renovations to clubhouses, pools, common areas and other amenities across those three properties and two others it acquired in 2023.
Tailwind is pursuing development, as well. It plans to add 328 beds to an asset in College Station, Texas, that it bought in 2022, and it expects to break ground on a new project near St. Louis University in the second quarter.
For 2024 Smith and others anticipate seeing an increase in opportunities fueled by refinancing risk. These are cases where developers and operators have failed to achieve stabilization or the rent growth they had envisioned, and now they are out of loan extensions or are facing the prospect of having to come out of pocket with fresh capital to refinance a loan coming to term.
“We think that those situations are going to force some sellers into the market, especially those with older assets that need capital,” Smith predicts. “It may not be across the board at all universities, but I think it’s coming soon.”
For Lyons, the market has been reminiscent of the period following the Great Financial Crisis. But he, too, anticipates a shift coming.
“Eventually sellers came to understand the new normal, and the dam broke,” he recalls. “It’s about to happen again. This will be a transition year, and then in 2025 the dam will really break.”
—Joe Gose
This article was originally published in the January/February 2024 issue of Student Housing Business magazine.