Student Housing REITs Should Outperform The Market In 2014

Includes: ACC, APOL, CCG, EDR, GHC
by: Zvi Bar


Student housing REITs performed poorly in 2013.

These REITs provide above average dividends and are now trading at more compelling prices than they have in several quarters.

American Campus recently provided leasing data indicating decent application and occupancy rates, as well as a 2.1% rent increase, which should bode will for ACC and the industry generally.

College students generally have three options when it comes to where they will live. They can stay at home, in dormitories and other campus housing options, or in options that are near their college campus. Student housing REITs generally own and operate residences that are on or close to schools. Most of these REITs performed terribly in 2013 for various reasons, several of which I will discuss, but the industry does appear poised for a turn-around, which should make any weakness both a short and long-term opportunity.

There are not many publicly traded student-housing REIT options, but examples include American Campus Communities (NYSE:ACC), Education Realty Trust (NYSE:EDR) and Campus Crest Communities (NYSE:CCG). These companies all performed poorly in 2013. Over the last year, CCG has declined around 40%, and while its two larger peers did better than that, ACC declined by around 17% and EDR declined by around 11%. See a 1-year performance chart (Source: Google):

Within 2014, the two larger of these REITs, ACC and EDR have both begun to rebound, while the newer and smaller CCG stumbled in late February and fell over 10% after reporting disappointing results. See a YTD performance chart (Source: Google):

The above charts also both show the high level of correlation that generally exists within this industry and especially between ACC and EDR, which have performed very similarly over the last year. The considerably smaller CCG has noticeably underperformed them, but was highly correlated to the group in 2013 and only decoupled more recently, and after its disappointing report. Since then, ACC and EDR have steadily appreciated. CCG will likely re-couple with the group over the longer term, or become a potential acquisition target if its weakness continues.

Reasons for the 2013 underperformance include financing options for both the REITs' customer base and the investment community. First, there were the seemingly biennial concerns over ballooning federal student loan rates due to a dysfunctional congress. Such a rate increase would make the cost of an education, or at least the financing component, more expensive, forcing many students to choose cheaper options. This might mean choosing a less expensive college or housing option, or more students deciding that the better option is to stay at home longer.

Another major issue for the industry was the generally poor performance of fixed income in 2013. Taper talk and a generally strong equities market hurt many fixed income investments, including many high dividend-paying alternatives such as utilities, MLPs and REITs. REIT dividends are generally taxed as income and not at the lower qualified corporate dividend rate, and many investors treat them as a fixed income allocation. Moreover, some of these REITs hold long-term debt that periodically adjusts depending upon interest rates and there is a general concern that spiking rates can dramatically change financing costs. Higher rates can also simply make future development more costly.

There is also a concern that higher education may become less relevant in the future due to changes in the education process and employment demand. Many complain that far too many students are getting costly educations that do not sufficiently increase the graduate's earning power to justify the time and expense, including the sizable burden that student loan debt can be (something like having a mortgage without a house, except student loan debt is even more difficult to discharge in bankruptcy).

Further, technology has already dramatically changed the way students are learning, including access to information, and it is entirely likely that future changes to educating students at every level will be even more substantial. While it is difficult and often dangerous to presume what the future of anything might look like, it does seem likely that online access to lectures by respected professors at top universities will increase, as will the existence of online programs that will be competitively priced and eliminate the need for student housing.

There are already many for-profit entities, such as The University of Phoenix, which is owned by Apollo (NASDAQ:APOL), or Graham Holdings' (NYSE:GHC) Kaplan University, and it is likely that online options will only grow over time, including competition from existing universities. The for-profit education business has also had its own set of recent problems and it seems apparent that these companies will have to evolve along with the larger industry. Nonetheless, these companies have shown that an education can be largely to wholly earned online, and traditional schools have certainly taken notice of the threat and opportunity that this new mode presents.

Campus Crest, which is the smallest, poorest performing and highest yielding of the above-mentioned student housing REITs has the greatest risk and reward potential. The company now yields about 7.65% and has a price to funds from operations multiple of about 11.6 (many consider this multiple to be the equivalent of a PE multiple for traditional equities). The yield increased from around 6.5% to its current rate over the last year because of the poor equity performance rather than any payout increase. The company has maintained its present $0.165 quarterly dividend for the last five quarters. The market may also be anticipating a possible reduction to the dividend because of the relatively poor recent results.

Campus Crest went public in 2010, at which point it owned 27 properties. The company now owns 71. The company had historically grown its business by developing properties, but in 2013 it departed from its model and acquired a 67% interest in 30 Copper Beach properties, plus a purchase option for seven additional properties.

Copper Beach properties are essentially townhome communities. Campus Crest's other properties are mostly branded under the Grove name, and are considered garden-style properties with residents having their own bedroom and bathroom, plus common areas and competitive amenities. CCG also has an Evo line, which is a luxury urban high-rise branded property type.

It is quite possible that the company's move to acquire Copper Beach was a mistake and that the company will be paying for that mistake for a while. Thus far, the deal appears dilutive. In December, CCG sold off 4 Copper Beach properties, indicating that the deal might not have been as good as it originally believed, and also that CCG needed to improve its balance sheet. It is also quite possible that the management expense for such properties is greater and also that the work is more of a hassle, as is generally the case with houses when compared to apartment buildings.

Further, the company has some debt that matures in 2016, and it is possible CCG wants to refinance in advance of that occurrence. Campus Crest estimated 2013-14 development costs to be $118 million, which works out to about two-thirds of cash on hand. Future development would likely require the company to obtain additional financing, issue more stock through a secondary offering, or sell some properties to develop others.

Recently, American Campus Communities, which is the largest of these student housing REITs, provided an interim leasing update for the fall. ACC noted that their pre-existing wholly-owned portfolio of units was 78.9% applied for and 70.5% leased compared to 71.2% applied for and 64.7% leased at the same point last year. ACC also projected a 2.1% rental rate increase over in-place rents. Beyond its 167 wholly-owned properties, ACC also manages 33 properties.

This is quite positive for ACC, as it indicates that even with rent increases, occupancy rates should be at or above last year's level. Additionally, ACC's new wholly-owned properties are 83.3% leased, bringing the total wholly-owned portfolio to 71.3% leased. This indicates that ACC's recent property additions were good ones and quite possibly better than the average pre-existing property in the company's portfolio.

What ACC's interim results also indicate is that, at least for the near term, is that concerns over reducing demand for college and potential difficulties in obtaining student loans have not yet affected ACC's business, or at least that any disturbance has not prevented the company from increasing rent while maintaining prior occupancy levels.

In the coming year, it appears probable that campus housing REITs will outperform the market, both because of prior underperformance and a recent resurgence in investor demand for income producing equities. The likely outperformance may be pronounced if the market broadly corrects. Nonetheless, investors should recognize that the industry will be sensitive to any possible forthcoming interest rate increases.

Disclosure: I am long ACC, CCG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.