United States

School’s Out for Summer

(Or forever?)

INSIGHT ARTICLE  | 

It seems as if we are living through an alternate version of Alice Cooper’s song. While the COVID-19 pandemic has had a significant impact across real estate sectors, student housing, once a beacon of stability, is now vulnerable as universities rethink their plans for the school year.

Universities mounted rapid responses to the pandemic in March with broad-based cancellation of in-person classes and more than 80% of on-campus residence halls closing.

For investors, it all came as a rude shock. After all, student housing was long believed to be recession proof and was a darling of the alternative-investment scene.

Distressed players make their move

With the pandemic as a backdrop, the number of distressed debt funds looking to raise capital has reached a record, with 60 funds in the market representing a combined $72 billion in capital targeted, according to Preqin. This comes as capital targeting real estate reached a record $103 billion in 2019, though the fundraising landscape was softening as the number of funds declined to 235, the fewest in seven years, according to Preqin.

The distressed funds are betting on increased stress and defaults in the marketplace, with this year’s targeted capital in this strategy doubling the 2019 targets as reported by Preqin.

Adding more fuel to the distressed fire, Preqin reports there is $68 billion in dry powder through June with funds lining up to take advantage of those industries most affected by the pandemic.

Transactions lag

Investors have pressed “pause” as they take a cautious approach during the environment. Expect to continue to see an overall lag in transaction activity for some time as pricing remains difficult.

As valuations have gyrated, there are fewer ways to make comparisons that help set expectations between buyers who believe they deserve deep discounts and sellers who view the coronavirus as a temporary inconvenience. The difficulty in assigning value is only compounded by the inability to physically view a property or accurately project future rent payments.

Public REITS including American Campus Communities pulled earnings guidance, citing the uncertainty about the length of time that shelter-in-place orders will continue.

“We are unable to predict the full magnitude of the pandemic and its effect on our results of operations through the remainder of 2020,” Daniel Perry, the company’s chief financial officer, told investors in an earnings call on April 21. The campus closures for the 2019-20 academic year led to rent refunds and delinquencies, and leasing for 2020-21 is incomplete amid the uncertainty about students returning to campus.

The spot of good news is that this recession is nothing like the last one; because this is purely a pandemic-driven event, investors have ample capital sitting on the sidelines waiting for transaction markets to open up. This availability should ensure that the market maintains liquidity and pricing doesn’t collapse.

Leasing for the school year

Student housing has fared well compared to other asset classes during the pandemic, but it still faces headwinds with leasing for the 2020-21 school year. In terms of collections, April and May 2020 didn’t look too out of line with historical rates — the industry collected 93.9% of rents in April and 93.4% of rents in May 2020.

If most colleges stay on course and go back on campus in the fall as expected, the industry could see leasing levels move closer to the historical average. Universities, after all, face pressure to capture tuition and have an incentive to reopen with in-person classes.

Leasing in the next month will be vital to the business of student housing operators. As schools clarify plans, students are leasing beds for the fall. Jennifer Cassidy of Campus Advantage stated that during the first month of the pandemic, the industry was signing only 50% of the leases that they had secured at the same time last year.

When schools began announcing a return in the fall, leasing activity shot up to 80% of the activity at the same point as the prior year — an encouraging sign for the industry. To catch up for this lost leasing activity in the spring, student housing operators have been working hard to capture the summer leasing.

Another reason for the resiliency of the student housing sector? Need-based financial aid increases during times of financial hardship and can aid student housing leasing.

So far, major players in the sector are saying that not even COVID-19 has had a significant impact on the fundamentals of pricing student housing. Pricing power, coupled with expected new supply coming on more slowly given the downturn, will be a net positive tailwind for student housing.

An outdated housing stock

An advantage of the off-campus housing option following COVID-19 is that most new properties are modernized and set up for heightened safety standards with in-unit bathrooms, living rooms and full kitchens being the most desirable.

This apartment-style layout allows students to control and sanitize their environment. Conversely, most on-campus dorms are aged and consist of residence halls built in the 1950s and 1960s, designed for the boomers with communal bathrooms and shared spaces.

There is an additional opportunity for investors in student housing to partner with universities to upgrade the aging residential stock and replace it with purpose-built living and learning communities.

Companies like American Campus Communities also note that purpose-built student housing that is walkable to classrooms with modern amenities commands a pricing premium and is in high demand.

To bring students back, or not

Even if students have every intention of being on campus this fall, spikes in COVID-19 cases throughout the country could cause leasing cancellations and a reduction in occupancy for the 2020-21 school year.

The future of higher education will include some form of electronic content delivery.

In some cases, properties are hedging their bets by entering into master leases with universities agreeing to house students in case coronavirus cases spike and students need to quarantine.

In a worst-case scenario, universities would send students home as they did in March and transition to full online instruction. In fact, several prominent campuses, alarmed by the rise in coronavirus cases, recently announced a reversal of their decision to reopen campuses in the fall.

But the decision to reopen remains in flux. The Chronicle of Higher Education reports that out of 1,235 colleges tracked, the majority, or 52%, have announced in-person classes, 11% are planning for online instruction and the remaining 37% are planning for a hybrid or are undecided.

It’s becoming abundantly clear that the future of higher education includes some form of electronic content delivery and those institutions that have focused on investment in technology and e-learning will gain the benefit of being the first to market and working through issues.

Still, students have made it clear that they want to be on campus regardless of whether their classes are in-person or online.

Unintended consequences

When students don’t need to physically be somewhere to take a course, why not get the best in class learning that is available? The incremental cost to providing e-learning is minimal to an institution and therefore there will be a flight to quality. Why take a course at a smaller regional college when you could be credentialed by Harvard?

There has been a move for the democratization of higher education and the pandemic has accelerated the long-term trend. In the future, market share is increasingly important and there will most likely be further consolidation as smaller institutions don’t make it through the current cycle. State and local governments are strapped for cash given the pandemic, so even public institutions may not be immune.

Is higher ed dead?

Some may argue that we’ll never get back to a reality where a four-year college experience remains the accepted norm. Investors in the student housing sector continue to bet that the benefits of an in-person education cannot easily be replicated online. Studies even show that predominantly online educations have an increased probability of student dropout.

Students also lose the benefits of in-person mentoring from instructors, tutoring and hands-on lab experiences and group projects. And that doesn’t account for the loss of personal growth and life experiences that come beyond the classroom on campus.

A study by Brookings Institution shows that four-year graduates have been less affected by the financial fallout from COVID-19 with the unemployment rate spread between degree earners and non-degree earners increasing by 210 basis points to 970 basis points between December 2019 to December 2020.

The takeaway

For investors in student housing, the coronavirus has upended what was once thought to be a sector immune to the vagaries of the economic boom-and-bust cycle. But as universities adapt, the demand for modernized housing that meets the needs of today’s students will continue to evolve.

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