“The property is located at a first tier university.” We often hear this when offered properties to buy or build in student housing.
Everyone in student housing labels a university “1st Tier,” “2nd Tier,” or “3rd Tier,” but no one uses the same definition. Tier labeling is typically based on one of the following models: 1) U.S. News and World Report rankings; 2) high-value football team; 3) enrollment size; or 4) academic standing. When quizzing industry participants about how they categorize, the answer is always fluid (often depending on whether they are promoting a project in the market). Two of these measurement systems appear flawed:
1. U.S. News and World Report dramatically changes its rankings every year. In the time it takes to build a project, the ranking will change, making this measure less meaningful.
2. A college with a high-value football can be ranked “First Tier,” but if the university does not have one, how do we determine if the college is “Second Tier” or “Third Tier?” A number of great colleges exist without revenue sports.
One leading student housing broker ranks tiers by enrollment:
• Tier One — 20,000+,
• Tier Two — 10,000-20,000
• Tier Three — Less than 10,000
By these definitions, a lot of community colleges are ranked Tier Two and even Tier One. While this model has merit, it does not distinguish academic quality.
Diamond believes the appropriate way to rank universities is by academic quality. Experience gained by investing in 27 student housing projects in 22 markets indicates that properties serving schools with high academic standards enjoy:
• Lower property turnover (higher graduation/renewal rates)
• Lower collection losses (lower dropout rates)
• Earlier in-season lease-up (not a last choice school)
• Less property damage and management trouble (not party-oriented)
• Lower cap rates on sale (buyers prefer better schools for the above reasons).
The choice of a metric for academic quality is controversial. There is a lot of subjectivity as all universities have both strong and weak programs for various fields of study. Diamond settled on using the American Association of Universities (AAU) list to define Tier One. This Association has only 62 member universities. The list includes both private and public universities that are arguably the best of the best in the U.S. and Canada; the list can be found at www.aau.edu. Most people will agree these universities are the most highly regarded in North America. The list has seen minimal change over the past few decades.
We define Tier Two as being a state flagship university, or one with a high value football team and enrollment greater than 15,000. Tier Three are schools that do not fit any of these categories.
The defined tier of a university does not directly tell us if the market is a good one for student housing investment. Many of the most highly regarded AAU-accredited schools, such as Harvard and Stanford, have essentially no market for institutional student housing.
To determine if buyers really do pay different cap rates — and what are they — at the various tiers, we did a transaction analysis of reported student housing sales. Our study examined 129 institutional sized student housing transactions in 2011 and 2012. (The data excluded one large portfolio transaction acquired by American Campus Communities.) Cap rate data is always difficult to obtain and can vary widely among quotes. Thus, Diamond evaluated only transactions we had insight into such as offering packages, or close relations with a credible deal participant. The cap rate determinations were carefully made with consistent underwriting.
The results of the study are shown in the following table:
Tier Assets Beds Avg. Price/Bed Avg. Cap Rate
1 40 24,921 $78,245 6.0%
HVF* 53 29,322 $71,234 6.1%
2 76 49,071 $53,139 6.4%
3 13 6,858 $31,059 7.1%
* For this column in Student Housing Business, we added a special Tier just for colleges with high-value football teams. It is labeled “HVF” in the above table and includes schools we consider both Tier 1 and 2.
Clearly assets around the AAU member schools trade for the highest values and lowest cap rates. The reason is not just prestige. These schools provide a high degree of enrollment stability. Students who are accepted to these schools tend to secure housing early and renew because a higher percentage stay and complete their studies. The value and costs are also higher because many of these schools are in fully built-out locations where land is a premium.
Based on our study, Tier 2 schools have significantly lower trade prices, but not dramatically different cap rates. Many Tier 2 university markets are wonderful for student housing investment. Flagship schools enjoy steady enrollment demand.
Many of the trades we examined at Tier 3 schools were made due to a troubled situation. Smaller schools in commuting locations sometimes do not have the housing demand to support more than just a limited shadow market.