Investors up and down the capital stack continue to look favorably at the student housing sector and seek opportunities to deploy more capital in the space, according to executives at the 2014 NMHC Student Housing Conference & Exposition. This interest, backed by the sector’s solid fundamentals, is being reflected in higher valuations and falling cap rates. In fact, cap rate spreads between student housing and traditional multifamily have reached historical lows. However, despite widespread capital availability, deal flow is only now beginning to pick up following a sluggish first half of the year.
(Get a rundown of all the sector’s key indicators in the presentation, What Do Capital Markets Tell Us About the Prospects for Lending and Investing?, by Colliers International’s Dorothy Jackman, managing director, and Brian Ward, president of capital markets.)
On the debt side, all the major sources of debt capital are active in the market, with a number of executives noting that insurance companies had become increasingly aggressive in competing for deals. In contrast, government-backed Fannie Mae and Freddie Mac appeared to be pulling back to some degree, despite a lifting some of the agencies’ earlier lending restrictions.
In particular, Rich Martinez, vice president of production and sales with Freddie Mac, said his group was beginning to see some weaknesses showing up in its portfolios, pushing the agency to remain disciplined in evaluating deals. He qualified the statement by saying the weaknesses weren’t severe enough to be moving deals into work out territory, the under performance was noticeable enough to prompt him to put more deals onto a so-called “watch list.”
In terms of equity, executives again said the sector was generating a lot of interest from a variety of players. Foreign investors, in particular, were looking for opportunities but having a hard time finding the right deals to meeting their investment objectives; student housing deals generally were too small to fit foreign investors’ investment profiles. In addition, regulations on foreign capital posed significant hurdles.
Executives also noted that both construction and acquisition deals were getting harder to pencil. Rising costs and an uptick in development and delivery delays and operational misses related to occupancy and rent growth rates were affecting construction and acquisition pro formas, respectively.
Many believed this undercurrent affected the transaction market, which was reportedly slow through the first half of the year. While most executives agreed that the pace of transactions had picked up through the summer into the fall, the market’s shift to a lower gear raised questions and spirited debate about student housing valuations and whether they had become overinflated.
Several executives argued that, as the student housing market has matured, it’s become a clearly recognized and established asset class. Investors now understand the sector and value its performance relative to other asset classes during down cycles. This mainstreaming of the sector supports similar valuations as those found in traditional multifamily, so the argument went.
However, several executives strongly disagreed with this assertion, pointing to the sector’s idiosyncrasies as meriting a risk premium that keeps valuations lower than traditional multifamily.
For example, delivery delays can be disastrous not only for the provider directly involved but for the larger local student housing market as well. Similarly, student housing pricing is inflexible and unforgiving in many ways; unlike traditional multifamily pricing, which can be adjusted monthly as existing leases roll off the books and are replaced with new ones, student housing providers only have one shot-the beginning of the school year-to get it right. And the sector’s higher operating costs also warrant consideration, they argued.