New Velocity in Investment Market

Increased activity in the student housing investment sales market bodes well for 2010 and beyond.

While the student housing sector weathered its fair share of the market slowdown last year, activity has been picking up in the sector as investors are moving back onto the playing field, sellers are putting more product back on the market and newcomers to the student housing investment sales market are beginning to look at this product type as a new and solid investment for their portfolios.

Increased Activity

Fred Pierce of Pierce Education Properties notes that between 2004 and 2008, more than $10 billion in institutional student housing apartments were purchased, an average of $2 billion per year. This is in contrast with 2009, in which only a little under $400 million was transacted with most of those sales being small deals. However, Pierce points out that in 2010 things have started to look up for student housing investment sales. “So far through the first quarter, there was $191 million in student housing transactions, and although that was heavily weighted by a large NYU deal, it would not surprise me if $1 billion in deals happened this year,” he says.

Dorothy Jackman, vice president of investments and senior director of Marcus & Millichap’s national multi-housing group, points out that as activity heats up, more sellers are putting properties on the market. “Sellers know that equity has been sitting on the sidelines and are now willing to deploy capital into deals,” she says. “Sellers are also seeing a minor compression in the cap rates, so now they want to have assets on the market. As well, buyers are definitely out there.”

Ryan Reid of CB Richard Ellis believes that by the latter half of 2010, transaction levels will be somewhat back to normal. “Not back to peak of 2006 and 2007, but certainly not like what we saw in 2009,” Reid explains. While Reid does note that there is still not a tremendous amount of product currently on the market, he believes that momentum will increase as the year goes on. He and his team have already had a handful of student housing deals close this year and they have several other deals either under contract, in negotiations or a contract is pending. “We are also reviewing a lot of assets for clients, which is a signal that things are going to pick up even more,” he says.

Although it is a bright spot that sales activity is increasing, much of the activity is being driven by short sales or foreclosures. According to Carlton Dean of Sperry Van Ness, in the first quarter of 2010 nearly $100 million in student housing sales transacted, and in the last 12 months nationwide, more than $520 million in student housing transactions have taken place. However, Dean explains that these numbers are somewhat deceiving. Many once favorable markets, such as Gainesville or Tallahassee, were overbuilt and therefore are now suffering with distressed sales that are finally coming to market. “Based on the market activity that we have seen through the first quarter of this year, 2010 has indicators that there will be higher sales volume than the previous year which points towards a bottoming of this market sector in 2009,” notes Dean. “We are seeing activity dramatically increase from what we saw in 2009, particularly in the $2 million to $10 million price range, however these values are still depressed,” he says.

What is Selling?

Thus, it is not surprising that distressed opportunities are still at the top of the list when it comes to exactly what investors are looking to buy. Dean remarks that most properties that traded in fourth quarter 2009 and first quarter 2010 all had some degree of distress to the disposition. “In Tallahassee, for example, the last three student housing assets to sell were all lender owned and there are another 11 properties pending that are lender owned,” he says.

While the majority of the properties coming to the market are distressed in some way or another that does not mean that all of those properties are still being sold for rock bottom prices. “Today, since we are seeing compression in cap rates, and if it is a good asset, there is more of a feeling of good fair pricing, especially for private capital investors that can still lock in attractive long-term financing,” says Reid. Dean notes that much of it has to do with the class of the asset. “The Class A properties with good occupancy are still seeing cap rates in the mid 7.5 to 8 percent range while other older assets are grabbing the attention of bottom feeders who are offering prices based on ‘in place’ rent with cap rates north of 10 percent,” he says. “Most recent student deals have averaged closer to 8.5 to 9.5 percent cap rates, primarily because the recent deals have been motivated sellers.” Reid adds, “Anytime there is a distressed label on an asset it is getting tremendous interest.” However, he does note that his clients are not interested in distressed or under-performing assets, but more so they are looking for distressed situations. Investors still want core properties with sold rent growth and desirable locations.

Pierce explains that his firm is looking at two asset profiles. In both cases, physically the firm is looking for similar traits — Class A, purpose built, highly amenitized, institutional size student apartments. “These are developments that are 400 beds or more, a cost of $10 million of more, aged from 1995 or newer, and close to a university with 15,000 students or more, and we have a strong preference that the university has Division I athletics, preferably football or basketball,” he says. The company plans to pursue projects nationally and they are also keeping their eyes open for 95 percent occupied stabilized properties and value-add opportunities.

While this might sound like what everyone else is looking for as well, Pierce believes that one of their parameters gives them an edge in the current stratified marketplace. “When the market value of an asset is in the $10 million range there is an exponentially larger number of buyers, so much so that it even goes beyond the expertise of student housing operators and will attract other high net worth investors,” he explains. “However, if the asset is priced above $20 million there is a very thin range of buyers to compete with, so we are enjoying that advantage.” In the next 12 months, Pierce Education Properties expects to acquire more than $200 million in student housing assets. “Today we have outstanding offers on student housing apartments in the value of about $150 million. Not all of those may come to fruition but that is what we have pending,” Pierce says.

Brian Thompson of Harrison Street notes that right now many investors are zeroing in on quality assets that feature unique concepts. “There have been some new concepts that have been rolled out in student housing such as the cottage concept and some product that is really unique with students and lenders,” he says. “Those types of products are really getting interest from buyers, lenders and students, and that is what really generates value in these assets — where the students want to live — in terms of rent growth and occupancy rates.”
Frank Duemmler of Kayne Anderson Real Estate Partners says that while his firm is looking for similar types of deals as mentioned above, they are further widening their spectrum and are looking at getting involved in developing future student housing projects. While there has not been as much construction in the past few years for obvious reasons, Duemmler notes that lenders are becoming more open to construction loans for the student housing sector because of its continued success even during the recession.

Who is Buying?

Although investment sales activity is picking up not all of the players from the past have returned to the marketplace. Overall, private capital is still king in terms of buying power. “Right now there has been so much more capital sitting on the sidelines for so long that there are many groups that are itching to deploy it in sectors that have shown to hold up in this economy, which are student housing, senior housing and medical,” Thompson says. “Those that have been sitting on the sidelines and watching the market are seeing that student housing is recession resistant.”

Dean adds, “Larger players such as The Scion Group, Julian LeCraw & Company and McKinney Properties have all closed transactions recently, but we have also seen a number of acquisitions under $3 million by smaller investment groups and individuals.”

Although more people are buying, they are still being cautious. Dean explains that most investors are sticking closer to “home” and buying in markets where they already have existing product and management teams in place. “There is a continuing trend of out of state owners that are selling and exiting markets that are further away from their home base, and an increasing percentage of buyers that live in the state where the asset is purchased,” says Dean.

While private capital is exerting more purchase power, Reid does note that some institutional buyers are starting to get back in the market. For example, he notes that his firm has a fairly large portfolio on the market right now for The Dinerstein Companies and it is getting some interest from institutional buyers but it remains to be seen how serious they are.

Some of those with the capital to buy right now are also new faces to the student housing sector despite the fact that student housing does require more expertise in terms of management and operation. “Firms like ours have funds established specifically for acquiring student housing assets, but you are also seeing institutions and other funds that did not have a focus on student housing that are beginning to look at it rather than multifamily for example,” Duemmler explains. He notes that the increased interest comes from the overall performance of student housing properties throughout the recession, making it seem rather recession proof compared to other sectors within commercial real estate.

Who is Not Buying?

Those that are still not buying were some of the biggest players in the student housing market in the mid 2000s — the student housing REITs and TICs. According to Pierce, specialty student housing REITs were the top buyers for many years. “In 2004, REITs were the buyers in 76 percent of student housing transactions; in 2005, 62 percent of transactions were bought by REITs; and in 2006, 59 percent of transactions were bought by REITs,” he says. Now, however, there are only two REITs remaining in specialized student housing, and both of those REITs for the time being are not actively pursuing acquisitions, in fact, Pierce notes that both have said that they were going to be net sellers. In addition, many TICs are struggling right now with under-performing properties and challenges with capital calls. Going forward, Pierce believes that the student housing investment sales market will be dominated by joint ventures between student housing operating companies and high net worth buyers.

The Future of Student Housing Investment Sales

Despite a still somewhat precarious economy, the student housing sector continues to be a solid choice for many investors. “From a fundamental stand point we are well positioned to see a nice performance out of the sector for the next three to five years because construction is limited and schools are still going to get pressure to grow,” Reid says. “It is a really good time to be buying student housing because of good rent growth, very little supply on the market and continued enrollment.”

Thompson agrees, noting that the student housing sector is going to see a surge in activity over the next 12 to 24 months due in great part to so many groups that have been sitting on capital for some time and need to deploy it. “They are seeing that student housing is holding up really well and it is proving itself before our eyes, he says. “But whether that translates into lower cap rates and more competition for assets remains to be seen.”

Reid explains that as the student housing sector continues to show improvement there will be more and more capital that will want to invest in it because the sector has shown itself to be a little more stable than multifamily or other sectors because it won’t be as greatly affected by swings in the job market. Plus, a steady flow of loan maturities coming due in 2010, 2011 and 2012 will also ratchet up investment sales.

“Many of those properties will not hit pro forma projections made for them because there has been enough softening or flattening where rental rate growth may not occur; thus, the loan-to-value is not there. Borrowers are faced with paying down mortgages and those borrowers are generally not in a position to put additional equity into those deals, which is causing properties to come to market,” explains Pierce.

Because of changes like this, deals are now more individualized, says Jackman. Pricing for assets is now based on a project’s performance, rather than comps or pro-formas, as in the past, says Jackman. “The price is now based on asset quality, the type of financing you can get, how well the property has historically operated and other variables.”

As for 2010, Jackman sees pricing increasing along with the interest in the student housing sector. “Pricing will be less depressed than in 2009,” she says. “It’s not going back to the levels of 2005 or 2006 where pricing was based on the market [velocity], but instead, pricing is based on the fair market value of the individual property.”

Duemmler agrees that there will be an increased interest in the student housing sector, but he also cautions that much of the sector’s future activity will depend on how some of the other sectors of commercial real estate fare over the next few years. “If people become more active in purchasing office or multifamily again some of the funds that look at broader investments might go back to those sectors so it might reduce the current increased interest in student housing,” he says.

Many of the issues currently facing the market are short-term and all of our experts agreed that student housing at major universities has historically been one of the most stable performing assets in the commercial real estate market and should remain so now and into the future.