In today’s slow-growth economic environment, the student housing sector is enjoying its day in the sun. Both equity and debt players like the market’s long-term fundamentals and cash flow and, consequently, are looking to deploy more dollars into the market in the year ahead.
On the equity side of the capital equation, outside of traditional private equity players, pension funds, endowments and sovereign wealth funds are increasingly interested in student housing. Given that they typically are conservative and have a low-risk appetite, student housing is a good fit for them because the sector offers cash flow, is becoming more sophisticated in terms of fiscal and operational management and is less correlated with other real estate sectors, particularly those prone to boom and bust cycles.
That said, there’s a desperate search for yield, which can be a hurdle in today’s market. Moreover, many of these investors want lower leverage (55-65 percent loan-to-value) and a longer-term hold (10 years) to make a deal work. The other big issue for equity investors is that it can be difficult to achieve any kind of investment scale in the student housing sector. The size of the deals is limiting at the same time that some equity investors remain uncomfortable to one degree or another with the capital-intensive nature of the sector’s operations.
In the debt markets, Fannie Mae and Freddie Mac are still the big dogs when it comes to providing capital.
For example, Freddie Mac had its “best year ever” in student housing, according to Rich Martinez, managing regional director for Freddie Mac; the company is targeting $1.5 billion in lending this year. However, he said the Federal Housing Finance Agency, Fannie and Freddie’s regulator, has expressed concern about possible “irrational exuberance” creeping into the market again. To protect against the souring of more loans, Freddie has placed more loans on its “watch list” and plans to take a step back from the market as other players are coming into the market.
Although Fannie and Freddie dominate the market, executives believe the commercial mortgage-backed securities (CMBS) market is coming back, albeit slowly and at a less competitive price. David Schmidt, central region production manager for KeyBank Real Estate Capital, said, “There’s no question that the CMBS market is coming around, certainly on fringe deals.”
Life companies, although far from a go-to source of financing, are increasingly interested in niche opportunities. However, they remain a little squirrely about certain aspects of the business, such as by-the-bed leasing structure and furnished units.
With so much capital looking to find a home in the market, some student housing firms are seeing opportunity to make some strategic moves today to ensure longer-term capital availability. For example, one student housing REIT executive said the leadership team recently took steps to decrease the company’s debt maturities and shift away from secured debt toward unsecured bonds. This should allow the company to maintain favorable debt-to-total-asset levels but still have flexibility to grow the company if the equity markets move away from industry.
However, several executives suggested that a pullback in the capital markets might be coming. “We are entering that red flag zone,” said Al Rabil, managing partner for Kayne Anderson Real Estate Advisors. “We’re entering an inflection point where you see more capital, particularly on the debt side, enter the market. And we are seeing things get built that we don’t think should get built. ... We also are seeing weakness in markets, sometimes surprising, that doesn’t show up in historical data, supply or even enrollments.”