The student housing sector has been touted as pandemic-resistant over the course of the last year, and for the most part, that sentiment rings true. Many markets showed resilience in rent payments, and leasing levels, as well as maintaining investment and development activity even in the face of the many challenges brought on by COVID-19. But while communities near Power Five universities have had a relatively banner year, Tier 2 and 3 markets saw their fair share of struggles over the course of 2020. Enrollment rates at colleges and universities in tertiary markets were lower than their state flagship counterparts, and many Tier 2 and 3 markets had trouble reaching their standard levels of occupancy with uncertainty looming over the start of each new semester. While some Tier 2 and 3 markets performed at a lower-than-usual level, the outlook for the year is brightening with vaccinations and — hopefully — a return to normal life imminent.
“It’s very tough to generalize because every market is specific unto itself,” says Chris Epp, principal at FourPoint Investment Sales Partners. “That being said, if you were to compare Tier 1, state-supported universities to Tier 2 and 3 schools, it is fairly notable that the latter didn’t have the same amount of kids show up to campus. From an operating standpoint, some of these students — sometimes due to the demographic — were not as reliable at paying the rent as their contemporaries at some of the bigger, Power Five-type universities. Occupancy, rental rates and collections have not been as strong as they were in Tier 1 through the course of the pandemic.”
Sean Lyons, partner at Triad Real Estate Partners, agrees, noting that the trend is likely to continue over the course of the next year. “There is no question that Tier 2 and 3 student markets have been impacted the most by the COVID-19 pandemic and we expect to see that trend continue moving forward,” he says. “We recently completed an updated review of enrollment numbers at Tier 2 and Tier 3 universities and almost all of them saw enrollment declines. Several of them were in the 4 to 5 percent range and trending downward. The case could certainly be made that we have more colleges and universities than we currently need in the U.S., so it is my belief that these schools will continue to suffer the brunt of the fallout in the post-pandemic world.”
While enrollment numbers have been down, Epp predicts that 2020 will likely be the worst year with regard to COVID-19 impact. “If I hazard to guess, moving forward, I believe 2020 was the worst of it,” he says. “There was total uncertainty on whether or not students were going to show up. Rent rolls, investment activity and the performance of student housing properties in the 2020-2021 academic year are going to be the low watermark.”
Though Tier 1 markets performed well last year, there were still bright spots at the Tier 2 and 3 levels, according to Austin Repetto, principal at TSB Realty. “Capstone Real Estate Investments is a group that has excelled within Tier 2 and 3 markets through the acquisition of value-add opportunities. We recently marketed a portfolio of properties on behalf of Capstone that included a mixture of tiers and the level of interest was robust.”
“We believe Tier 2 and 3 markets will perform at levels consistent with previous years in 2021,” continues Repetto. “That means they’ll continue to be priced at a discount compared to the Tier 1 markets and that the larger institutional and foreign investors will largely pass on this submarket of the student housing sector. That said, we believe each market is unique and there will still be great opportunities within Tier 2 and 3 markets for strong, performing properties.”
Marvin Schnee, president of investment firm Sundance Real Estate Advisors, echoed this sentiment and maintains that great opportunities will still exist over the course of the next year in tertiary markets that serve colleges and universities with solid enrollment numbers.
Along those lines, Tim Roth, president of student housing at The Vecino Group, believes the industry will see a fair amount of assets in these markets up for sale over the next 12 months. “Market corrections like this tend to shake loose those that are not as well-capitalized,” he says. “Construction pricing hasn’t gone down during COVID-19 like it did during the 2008-2010 recession,” continues Roth. “Because of this, I think there will be less development in the lower tier markets. There’s not as much rent growth in Tier 2 and 3 markets either, so with the rising cost of construction, it will be more difficult to make projects pencil out without a greater amount of capital in the deal. I see this as an opportunity for buyers.”
Early indications show pre-leasing in Tier 2 and 3 markets slightly down overall, according to Repetto. “RealPage has it around 26 percent as opposed to 32 percent at this point last year — but I think that’s to be expected,” he says. “It’s early and there are still unknowns with regard to campus plans for fall 2021. Like everyone, we’re hopeful with the beginning of the vaccine rollout and optimistic that institutions will have a return to something closer to normal in 2021-2022. If that happens, we could be looking at record freshmen enrollment as all of the students who deferred their plans last fall arrive to campus.”
College Town Communities CEO and Co-Founder Timothy Sipe agrees, noting that pre-leasing for fall 2021 has largely been related to the quality of communication between universities and their student population regarding plans to reopen campus for the spring and fall semesters.
“If an institution has gone silent and shared very little to no projections of what life on campus will look like in the fall, we have completely flatlined with pre-leasing in those markets,” he says. “However, if a college or university has released statements or plans for what they expect to see happening in the coming semesters, we are seeing excellent pre-leasing numbers. Some markets even have better same-store numbers than last year. It comes down to consumer confidence and colleges and universities need to take the lead in providing guidance.”
When weighing potential pros and cons for investment and development in Tier 2 and 3 markets during 2021, Bill Fideli, founder and managing partner of William Fideli Investments, says a big positive is the potential for higher cash yields and higher all-in returns.
“The drawbacks would be that building a new development might overly impact a Tier 2 or 3 market, quickly pushing what was a well-performing market into over-saturation,” he says. “The buyer pool has also been limited compared to Tier 1 markets. However, as student housing becomes more of an acceptable investment class for institutions, the impact of this limitation will lessen.”
Investors expecting to see fire-sale pricing over the next year in Tier 2 and 3 markets are likely to be disappointed, according to Eric Jakimier, founder of Domus Student Living. “I would like to think the secondary and tertiary markets will stabilize over the next year,” he says. “Even when schools go online or hybrid-online, our residents would rather live with us than at home. Financial markets will rebound as they, too, will have gotten over the knee-jerk reaction that student housing is done for — we are still seeing that reaction right now despite what our financials show. Based on past experience, a sluggish and recovering economy will benefit us in Tier 2 and 3 markets, as those schools tend to be of better ‘value’ in terms of tuition and cost of living. We would like to sell an asset or two in the coming year and get back in the development game.”
In tertiary markets it is all about solvency, the relevance of the college or university and enrollment trends, according to Epp. “You want to invest at a university where you can point to a timeline in 10, 15, 20 years and feel extremely confident that that university will be around and that enrollment will have been steady or will have increased,” he says. “The topic du jour is whether or not COVID-19 capped some Tier 2 and Tier 3 markets, and I think the answer is yes — some are very likely to be absorbed by larger, state-funded universities. Others will go out of business, but a lot will survive, and it’s all about selecting the ones that will survive.”
— Katie Sloan
This article was originally published in the January/February 2021 issue of Student Housing Business magazine.