Tier 2 Attraction
University enrollment growth, better pricing and more financing options make for strong investments in non-flagship student housing markets.
It's a market with many names — "non-flagship," "secondary," "Tier 2" (which tends to have a less desirable connotation and, therefore, may be a misleading moniker), and more and more, it's a market that's attracting the American student. Some student housing developers believe non-flagship markets will be relatively untapped for years to come. Still others say they can quickly become overbuilt as many developers seek them out for their enrollment growth stories and often less expensive land. In fact, the bulk of the American demographic is attending non-flagship schools, according to Ted Rollins, CEO for Campus Crest Communities.
"In the past five years, we've seen a 12 percent growth in enrollment, which is more than the flagship schools," Rollins says. "47 percent of the students who attend public state universities go to non-flagship schools, and we've seen an average value proposition on tuition of about 17 percent less than flagship schools. We've also seen an increase in foreign enrollment and an increase in the average length of stay, which is currently about five years, versus four from the past few years."
Defining the Market
However you refer to the market, most define it similarly: a market with anything other than the "household-name" institutions – primarily flagship state universities with Division I athletic programs (e.g. UGA and Georgia Tech in Georgia). Certain metrics also play a role, such as growth rate of enrollment, financial aid and tenured professors.
According to Brian Shirken, Co-Founder & Principal for Columbus Pacific Properties, "any institution under 20,000 students is typically non-flagship, although there are some exceptions."
EdR has largely divested its holdings in most non-flagship markets. In the past few years, the company has re-positioned its portfolio to focus on flagship colleges and universities or on-campus ownership at non-flagship institutions.
"There are approximately 7,000 institutions of higher-education in the United States and approximately 3,000 of those are four-year institutions," says Tom Trubiana, executive vice president and chief investment officer of EdR. "We generally consider schools with enrollments of over 20,000 as flagship markets. Other factors we weigh are in-state, college-age population growth, university acceptance rates, school ranking, etc."
TSB Capital Advisors defines non-flagship university markets by schools with between 5,000 and 15,000 students that are experiencing enrollment growth and typically lack purpose-built, professionally managed, off-campus student housing. Other characteristics, says principal and founder Timothy S. Bradley, can include schools in less populous markets and universities transitioning from a commuter college to a traditional four-year university.
Dorothy Jackman, Managing Director of National Student Housing Group, says a 10,000 student population is the floor for non-flagship university markets from a student housing classification standpoint.
"The difference in non-flagship markets above 10,000 students is whether the university is growing and at what rate," Jackman says. "The distinguishing difference starts to be whether it's in an urban or rural setting. Urban communities tend to have a much higher barrier of entry from both a land availability/cost standpoint and regulatory/zoning standpoint. Most non-flagship schools tend to be in rural markets where there simply is unlimited availability of land, so new inventory will find a way to be built anytime revenue approaches levels supporting it."
Houston-based Innovative Student Housing is active in acquiring, developing and managing student housing assets in both flagship and non-flagship markets ("Tier 1 and Tier 2" as they refer to them), such as Ole Miss, Valdosta State and University of Toledo. According to CEO Doug Sherman, Tier 2 markets with enrollments of 12,000 - 20,000 students represent significant opportunity often overlooked by today's large funds, while selective Tier 2 markets have solid enrollment growth, a lack of A product and significant management upside. He says Tier 2 markets are often ignored by major equity funds because of a question mark on the exit strategy.
"For example, 70 percent of new beds coming online this fall are in flagship Tier 1 markets," he says. "But Tier 1 markets may soon become overbuilt and overpriced. This will drive investors to focus down market in the future."
By way of example, one Tier 2 acquisition Innovative made was at BYU-Idaho. The company purchased a 600-bed facility off-market at a below-market purchase price in May of 2012.
"The market has exhibited above average growth in enrollment over the past eight years, which was a key factor in the selection of the property," says Sherman. "The market has very little A-product, a common Tier 2 element, allowing for an easy competitive advantage with an A product. Also, the seller had no experience in student housing, and was also managing the property independently creating significant management upside potential."
Since acquisition, the asset has had a year-over-year rental rate increase of 7.86 percent, notes Sherman. In the first 12 months of operations, the cash-on-cash return was 18 percent.
"We attribute this success to best practice implementation among core property disciplines, as well as realigning the staff. The BYU-Idaho market is expected to maintain pace with the historically high enrollment growth of above 5 percent year-over-year."
Sherman also notes that many Tier 2 markets have experienced better than historical enrollment growth due to increased tuition costs or enrollment caps in Tier 1 markets.
Columbus Pacific is seeing far less development in non-flagship vs. flagship markets, which have significant overbuilding without significant enrollment growth. The company has acquired older, signature properties that are in need of major retrofits in order to meet current student needs.
"We also see far less competition in non-flagship markets, which enables us to accomplish higher rates of return with what we consider to be commensurate levels of risk," says Shirken.
Columbus Pacific recently purchased River Park on South Green and Rivers Edge on South Green, which are well-located on the south green of Ohio University's campus.
"We saw it as a terrific opportunity because of the location and the fact that the previous owner did not place a high emphasis on the resident experience, from pre-leasing and social media through the move-in and resident life experience," explains Dave Anderson, President of Homestead America & Homestead U, which provides management for Columbus Pacific Properties. "We added a pool and fitness center and updated everything in the common areas to give students the resident life they wanted. And we've had great success. We've re-branded the property and made it THE place to live at Ohio University."
The company also purchased Athens Apartments at Ohio University and re-tenanted the 120 units to student housing. When acquired last summer, it was roughly 40 percent student populated and is now up to 100 percent, even though it's located two miles from campus.
Similarly at The Ranch in Lubbock, Texas, which is also off-campus, social programming has taken the property to just about 90 percent pre-leased for the coming school year, which far outpaces where the property was last year, according to Anderson.
"For owners and investors, the social aspect is an important one," he notes. "It's everything from being proud of where you live to associating with a brand and logo straight through to the experience of what we offer for residents on a weekly basis."
While some see very little difference in the management and marketing style between properties located in flagship and non-flagship markets, Laura Formica, National Director of Marketing for Homestead America & Homestead U, understands the importance of customer service in the non-flagship space. She says urban flagship properties are competing for the wow factor with flashy amenities, while non-flagship properties are more service-oriented.
"I think everyone is trying to establish that there's a certain image and lifestyle associated with their brand," she notes. "What we're seeing at flagship properties is that flashy, urban, high-end luxury vibe vs. non-flagship properties, which don't like that big-city corporate feel. Non-flagship students want to know they are being taken care of. It's a totally different approach."
Campus Crest, which operates student housing communities in 60 markets in 25 states, features student housing properties in small towns or non-flagship markets in its product offering The Grove. In February of this year, the company acquired Copper Beech Townhome Communities, LLC and affiliates ("Copper Beech") with an initial investment representing a 48 percent equity interest in a portfolio of 35 student housing properties. The merger results in a combined portfolio of nearly 42,000 beds, creating the second largest public student housing platform in the United States by beds.
"About 33 percent of our Grove portfolio is weighted toward the flagship schools in smaller towns, and 67 percent is weighted toward non-flagship product," says Rollins. "We've noticed an overlap in about six markets with Copper Beach in that they had a different product type, which served a different constituency or sub-sector of the market — the upper classmen and graduate students who wanted less engagement and a little more independence. They were going to the cottage properties or those more residential in nature."
So Campus Crest added a product line and brand that would complement its Grove brand. Now, the company offers more shelf space in a market with two different brands and two different product offerings, adds Rollins.
"We thought it would give us operational efficiencies," he notes, "and it's very complementary in that a student can live in The Grove for two years and then move on to Copper Beach, and we get a little longer life out of that kid."
Over the next 90 days, Campus Crest will roll out a third, urban-based brand including a project in Philadelphia jointly developed with Brandywine Realty. In another joint venture, the company will participate in an urban redevelopment in Montreal. While a noticeable business line is developing in some of the more urban non-flagship markets, entering those markets is not always easy due to geographical limitations and/or the local approach to development, says Rollins.
"I think there's a lot of misunderstanding about the robustness of the entitlement and purveying process in a non-flagship school," he notes. "The confusion exists because people think it's a small town so you can do whatever you want there. But that university town has a very solid vetting process; they have a very protective mindset of their university town life. So the barriers to entry can be very high."
From a lending perspective, the most significant recent trend in the market is the fact that lenders of all stripes have embraced non-flagship markets on their merits, particularly the larger non-flagship schools, according to Troy Manson, Managing Director for HFF, one of the largest commercial real estate capital intermediaries in the country.
"We're now seeing core product in the larger non-flagship markets, which obviously attracts the agencies, with CMBS lenders, life companies and banks aggressively providing a solid alternative for deals that may not be a fit for Fannie and Freddie," he notes. "Overall, lenders place a little higher scrutiny on the smaller non-flagship markets. There is a perception that some of the smaller schools may be more affected by economic volatility than their larger counterparts."
HFF is currently marketing a new property called West 22 in close proximity to Kennesaw State University in Georgia, developed bySouth City Partners of Atlanta. KSU is an emerging university with enrollment of roughly 25,000 students. They are starting a Division I football program in 2015 and anticipating continued enrollment growth.
"The property offers an impressive mix of floorplans, some cottages and the best amenity package in the market," Manson notes. "While KSU may not be considered a flagship institution from a name recognition standpoint today, it already possesses many similar characteristics to those universities and is poised to continue in that direction."
TSB Capital Advisors has also seen more options for financing transactions at smaller schools with the return of CMBS markets and the overall increased interest from capital sources in the student housing space.
"In our experience, construction lenders provide similar terms for these markets with experienced and financially capable borrowers," says TSB's Bradley. "In markets with non-flagship universities, lenders will put a greater focus on details like capture rate, enrollment growth and future supply. Lenders are also using more conservative underwriting criteria with higher debt yields and debt service coverage ratio requirements on stable assets."
TSB defines non-flagship university markets by schools with between 5,000 and 15,000 students that are experiencing enrollment growth and typically lack purpose-built, professionally managed, off-campus student housing. Other characteristics of non-flagship markets, says Bradley, can include schools in less populous markets and universities transitioning from a commuter college to a four-year university.
Examples of markets TSB has consulted and closed transactions on include University of Louisiana at Lafayette (Lafayette, La.) and University of Southern Alabama (Mobile, Ala.), with deals in process at University of Western Florida (Pensacola, Fla.), and California State University-Monterey Bay (Monterey Bay, Calif.).
"Many of the concerns we face when analyzing non-flagship markets are the same as those in flagship markets, with a greater focus on how much product the university's off-campus student housing market can absorb with current enrollment and future enrollment of the university," Bradley says.
And future enrollment will certainly have an impact as more and more students choose to attend non-flagship universities.
As Rollins explains, "A college degree is becoming kind of homogeneous. The non-flagship state school systems are drawing more people with solid degree programs, a lot of tenured professors and some excellent specialty areas of study. We think these schools are really where America goes to college; that's our tagline, and really our play – build a great product at a reasonable price, charge a reasonable rent and grow the business."
— Susan Fishman