Investors are buying more student housing properties than ever before. “Last year was the biggest year ever, investment sales-wise,” says Fred Pierce, president and CEO of Pierce Educational Properties.

But hang on tight–this year is likely to be even bigger given the pace of transactions so far in 2016.

From the start of 2016 through mid-May, investors traded more than $3 billion in student housing properties, up from $2.1 billion over the same period in 2015, according to data from Real Capital Analytics (RCA). In comparison, in 2014, investors bought a total of $3.2 billion in student housing properties over the course of the whole year.

The same trends that made last year so busy loom even larger this year. Capital from around the world is interested in finding a home in commercial real estate properties in the U.S. At the same time, more investors see student housing as a core type of commercial real estate rather than a niche market. And a variety of financing sources are eager to provide permanent loans, equity and mezzanine financing.

“Interest in the student housing sector is as high as it’s ever been and is increasing,” says Doug Opalka, senior managing director for Holliday Fenoglio Fowler (HFF).

The Bigger, The Better

A few giant deals are setting the trend. “Homogeneous portfolio sales are defining the market,” says J.J. Smith, chief operating officer for CA Ventures.

This summer, a partnership of institutional investors, including the Canada Pension Plan Investment Board, GIC and The Scion Group, are expected to close a $1.4 billion deal to buy University House Communities Group, Inc., which owns 13,000 student housing beds. “That is going to create additional investment sales,” says Pierce. Giant portfolio sales like these often lead to spin-off transactions, as the buyers right size their new portfolios.

In March, private equity fund manager Harrison Street also finished its $1.9 billion acquisition of Campus Crest, which until now was a leading real estate investment trust focused on student housing, owning 38,000 student housing beds.

Smaller portfolios are also trading quickly, even though spring is usually a slow period for student housing sales. “We are now marketing three portfolios: two with five assets and one with ten,” says Jaclyn Fitts, national director of student housing for CBRE Capital Markets. “We’ve marketed 43 deals this year–a substantial uptick from last year.”

Usually properties sales, like everything else in student housing, revolve around the academic calendar. The best time to market a property is typically the fall, right after the property has leased up for the academic year. But now that sellers and buyers have so many deals to transact, they are using the rest of the calendar.

“You can’t market everything at once,” says Fitts. “People have realized you have to take advantage of the whole year.”

Who’s Buying, Selling

REITs have been the biggest sellers so far in 2016, with $1.9 billion in dispositions versus just $143.5 million in acquisitions, according to RCA. The vast majority of that activity is from the sale of Campus Crest. REITs were also net sellers last year, with $682.7 million in sales against $455.3 million in acquisitions.

“The large REITs (both public and private) have shown a tendency to be shedding their garden-style, outskirts product in favor of developing and acquiring infill pedestrian assets,” says CA Venture’s Smith.

The largest buyers include a growing list of institutional investors. “Pension capital has been very interested,” says Pierce. “I expect to see more and more capital allocated to student housing and more and more institutional investors enter the business.”

Institutions are attracted to student housing because the properties are relatively stable investments that provide consistent yields. Student housing has also proven to be highly resistant to economic headwinds. Rather than pinching demand, job losses in the economy often drive people out of the workforce and back to school, fueling student housing demand.  “Generally, you don’t see enrollment declines when the economy declines,” says Pierce. “These properties have great cash flow, great occupancies.”

As institutions commit more cash to student housing, they can buy larger properties. For example, in 2015, the Arizona State Retirement System (ASRS) increased its investment commitment for a student housing partnership with Pierce from $100 million to $300 million. Like most pension funds, ASRS avoids having more than a fifth of its money tied up in any single property. That meant that with a pot of $100 million dollars, and the ability to borrow up to half the value of a property, the most Pierce and ASRS could spend on a single property was $40 million. Based upon the new, larger allocation of $300 million, the upper limit for a single property was doubled.

Institutions like the ASRS and the Canada Pension Plan Investment Board have already acquired a total of $1.8 billion in student housing assets this year in the U.S., against just $133.3 million in dispositions. Institutions were also large net buyers in 2015.

International investors are also pouring money into student housing. “There are billions of dollars in transactions from foreign capital sources—Canada, Asia and the Middle East,” says Opalka. “The amount of foreign capital is meaningful and accelerating. Where else does it make sense to invest capital?”

Foreign buyers have already bought $1.8 billion in student housing properties so far this year, against just $133.3 million in sales, according to RCA. Foreign and institutional investors also buy student housing indirectly, by investing in private equity funds.

With so many new buyers investing in student housing, it is a challenge to find good properties to buy and strong partners to help operate the communities. “There are not a lot of operators,” says Fitts. “There are more new investors trying to get into the student housing than those actually getting in.”

Pricier Price Tags

Strong investor demand, low interest rates and falling capitalization rates have contributed to high student housing prices. While industry experts expect that, sooner or later, cap rates will creep back up, it’s a question of when. For now, rates seem likely to stay low.

“We will probably remain in a low cap rate environment for the foreseeable future,” says Opalka. “There is not a lot of upward pressure on rates.”

In the first quarter of 2016, the average cap rate for student housing properties was 6.0 percent, the same as the year before. The average price per apartment suite was $148,708, according to the latest data from RCA.

“As cap rates have compressed for multifamily properties, cap rates have similarly compressed in super-urban and super-pedestrian student housing,” says Pierce. Student housing properties generally trade at cap rates 50 to 75 basis points higher than conventional multifamily properties, according to HFF.

Investors pay more for student housing communities that are very close to campus, relative to the income from the properties. They accept cap rates 50 to 100 basis points lower to buy a new, Class-A student housing property located next to campus, compared to a new Class A property a mile away from campus, according to numerous experts.

However, some investors still find value in properties that are a mile or more away from campus. Many of these communities are still relatively new. Developers like Landmark Properties are still building a few new cottage-style student housing properties that have amenities such as resort-style swimming pools, volleyball courts and giant clubhouses. Properties located closer to campus often struggle to include amenities like swimming pools because they have to squeeze more beds onto a smaller lot.

In general, students pay more in rent to live closer to campus. Typical rents for a bed at a garden-style student housing community served by shuttle or bus transportation might range from $400 to $500 a month, while a bed at a community where the residents can easily walk to school might rent for $700 a month or more, says Pierce. That price difference helps keep communities full even if they are farther away from campus. “Those properties are able to appeal to a much broader subset of a renter base,” says Smith.

Investors also pay a premium for student housing communities located near large, state universities with Division I athletics. “These schools grow at a faster rate and are considered more stable,” says Fitts. Buyers accept cap rates 55 basis points lower for Division I student housing compared to cap rates for student housing located near compared Division II schools, according to CBRE.

Investors also pay more for collections of multiple properties. “Portfolios have been trading at a premium, if the portfolios are properly constructed, like-kind properties located at like-kind universities,” says Pierce. Investors are willing to pay cap rates 25 basis points lower and sometimes more for portfolios compared to single properties. While Pierce’s company historically bought properties one at a time or in small portfolios of two to four properties, it has recently been an active bidder on larger portfolios with six to ten properties, he says.

Developers are also finding opportunities in buying and upgrading older assets. “The value-added deals are the ones where I see the most juice,” says Lee Weaver, senior vice president for Northmarq Capital. The opportunities range from communities set a mile or more from campus where developers can add either more resort-style finishes or improve the transportation services to multifamily buildings closer to campus where developers can add bathrooms, new study areas or fitness centers.

Financing Forces

Just as investors are watching cap rates for signs of change, they’re also keeping a close eye on interest rates. A rising interest rate environment affects the cost of investment capital and can put a pinch on liquidity. However, volatility in the world capital markets earlier this year took some of the worry out of watching interest rates.

Late last year, it seemed likely interest rates could rise 100 basis points or more over 2016, as the Federal Reserve finally began to raise its benchmark rates. But bad economic news from China and Europe and capital markets volatility slowed down those plans and also sent many investors running for the safety of U.S. Treasury bonds, driving down the yield on the bonds. Since interest rates for most permanent financing are based on Treasury bond yields, that has pushed the interest rates for most permanent mortgages steeply down.

Whatever happens to interest rates over the rest of the year, so far rates are lower than anyone expected, while the U.S. economy continues its slow, steady, unusually-long recovery. That’s good news for market liquidity.

The availability of capital has helped fuel the boom in property sales. “You have a very liquid environment for both investment and financing,” says Opalka.

Permanent loans at low interest rates are available for strong properties and sponsors. So far in 2016, a typical first mortgage to a student housing property was a 10-year, fixed-rate loan that covered 65.2 percent of the value of the property, with an interest rate of 4.1 percent rate and a 2.11 debt service coverage ratio, according to an analysis by RCA of 77 first mortgages originated so far in 2016.

This type of loan is likely to be from one of the GSEs’ program.  “Fannie Mae and Freddie Mac are still the best lending source for permanent debt, for both price and loan dollars,” says Northmarq Capital’s Weaver.

The federal officials that have overseen Fannie Mae and Freddie Mac since they were seized in 2008 have given them a lot more room to lend. Last year, the Federal Housing Finance Agency ruled that loans to affordable housing properties are excluded from the limits on their commercial real estate lending. Student housing financing still counts under the lending limits, according to the regulators, but the change gave Fannie Mae and Freddie Mac room to lend billions of extra dollars—and they have been very busy.

Typical interest rates for their permanent, fixed-rate loans ranged from 4.15 to 4.25 percent, or 225 to 240 basis points over the yield on 10-year Treasury bonds, for loans that cover 70 percent to 75 percent of the value of a property, says Opalka.

But Fannie Mae and Freddie Mac can’t cover the permanent financing needs of all student housing properties. The agencies prefer to lend on student housing that serves large universities with more than 10,000 students enrolled in classes. Life company lenders also offer permanent financing for student housing with the best locations and amenities, often at very low interest rates.

Student housing properties located near smaller schools depend on other financing sources like conduit loans. However, conduit lenders are one of the few sources of financing for student housing properties that is harder to get this year than last year. Bad economic news from overseas shook up the international market for bonds at the beginning of the year–especially for bonds like commercial mortgage-backed securities (CMBS) that aren’t protected by a government guarantee.

The volatility made bond investors who buy CMBS less willing to accept riskier deals in the loan pools behind CMBS. Volatility hasn’t had much effect on the interest rates for conduit loans, however, as lenders made up for the rising yields on CMBS. “The all-in, coupon interest rates is about the same,” says Opalka.

Top Student Housing Buyers (graphic)

Conduit lenders currently offer interest rates ranging from 280 to 290 basis points over swaps for permanent, fixed rate loans. That works out to a total interest rate that is still below 5 percent. That’s much higher than what agency lenders offer, but it’s still feasible for properties located near smaller schools.

While there are a few limited areas where capital has pulled back, the overall student housing market remains flush with capital. This capital availability, along with a variety of favorable market factors like low interest rates, is turning deal flow into a deal surge. The transactions market this year is off to a sprinting start and, if it can keep pace through the back half of the year, 2016 could close out as a record-setting year for student housing investment.

Construction Lending Crunch

While there’s a lot of liquidity in the market for student housing investment in general, development deals are increasingly facing financing headwinds.

“The construction loan market is in general really tightening up,” says HFF’s Opalka. “We are getting calls from developers across the country—they are having problems.”

The student housing business is fundamentally healthy, with solid rent growth and high occupancy rates, according to the latest data from the pre-leasing season from Axiometrics. But banks have less capital available to lend to construction projects. “Some banks are backing away from construction financing altogether,” says Weaver. “The problem is regulatory.”

After the global financial crisis, laws like the Dodd-Frank Financial Reform Act in the U.S. require banks to hold a significant amount of capital in reserve to offset the risk of investments that they make, like construction loans. Now these rules have finally been put into practice, and many banks have already hit their limit.

“The leverage and availability of capital are going to be lower, and the cost of capital is going to be higher,” says Opalka. Many banks are demanding borrowers—or their partners—contribute more equity. Many banks now offer loans that cover 65 percent of the cost of development. That’s down from 70 percent or 75 percent two years ago. Interest rates are also higher. Many banks now offer interest rates that float 300 basis points over LIBOR, up from 200 bps just a year ago. For riskier deals, rates might float even higher, with all-in rates over 5 percent.

“Development yield are coming down,” says Opalka. “It’s harder to make deals pencil out. That’s probably a good thing for the market. It’ll keep supply in check.”

These smaller loans force many development partners to seek other financing like preferred equity or mezzanine loans. That’s because many developers have rigid requirement for the yield that their investments earn. “To make yields work, 65 percent loan-to-cost is not enough,” says Weaver. “You need to get to 75 or 85 percent.”

Many developers are also now seeking joint venture partners to help make up for the missing money. “There are any number of groups happy to fill that gap,” says Weaver. That includes balance-sheet lenders like pension funds and private equity funds. Crowdfunding sites like Fundrise have also provided some of that equity capital. “We sent them a bunch of deals recently,” says Weaver.

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