Student Housing: American Campus Communities Is Playing The Long Game

Summary

• After battling through a series of operational missteps and oversupply issues over the past two years, American Campus appears to have found its mojo once again.
• Disciplined capital allocation, along with the broader REIT Rejuvenation of 2019, has erased the NAV discount that had stifled the company’s external growth ambitions. FFO growth is projected to reaccelerate.
• While short-term fundamentals remain uninspiring, we remain confident in the long-term secular growth story rooted in the much-needed modernization of the physically and functionally outdated university housing stock.
• Enrollment growth is expected to remain flat-to-lower over the next decade, however, and the attitudes towards the traditional 4-year model of college education are shifting amid a backdrop of robust economic growth.
• As American Campus noted on their recent earnings call, the company is at its best when it's in acquisition-mode and able to put its operational efficiencies to work.

REIT Rankings: Student Housing

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Student Housing Sector Overview

Down to just one major player after the acquisition of EDR by Greystar in 2018, the student housing sector comprises 1% of the REIT Indexes (VNQ and IYR). Within our Hoya Capital Student Housing Index, we track the lone student housing REIT, American Campus Communities (ACC) which accounts for $6.5 billion in market value. American Campus owns roughly 110,000 student housing beds of the more than 5 million purpose-built student housing beds across the country. ACC's portfolio is primarily on-campus or near the campuses of major 4-year public universities. Small-cap REIT Preferred Apartment (APTS) also owns a portfolio of roughly 6,000 beds.

A microcosm of the trends seen across the REIT sector over the last four years, the student housing REIT sector has been gobbled up by the private markets. Private domestic and international investors, seeking a defensively-oriented and countercyclical real estate asset, continue to see significant value in student housing properties, pushing capitalization rates to levels on-par or even below their apartment peers. A record $11 billion of capital flowed into the sector in 2018 according to Newmark Knight Frank as the sector has quickly emerged from a niche business into a full-fledged institutional marketplace.

Student Housing REITs are among the most active developers in the REIT sector and utilize several different models to create value. American Campus has a number of different value-creation levers to pull. The most profitable of these models is the public-private partnership. A university, in need of new dorms but without the capital to build one, leases land to the REIT, which then builds, owns, and manages the facility. The university gets an annual ground-lease rent check (without deploying any capital) and the students get a new dorm. The university, in turn, often guarantees a steady flow of renters. For ACC, this partnership is called the ACE Plan. Revenue from these models comprises roughly a quarter of total revenue.

The other three-fourths of revenue typically comes from a traditional private off-campus ownership model (sometimes in partnership with a university) which is generally more exposed to supply/demand imbalances and changes in university housing policies. Generally, facilities closer to campus are believed to have higher barriers-to-entry and are less exposed to oversupply or other idiosyncratic risks. Over the last decade, rent growth and occupancy metrics have been significantly stronger at housing facilities closer to campus. While real estate ownership is the primary revenue source, these REITs also offer development, consulting, and management services to university partners.

Purpose-built student housing facilities are generally cheaper and are equipped with more applicable amenities for students than typical off-campus housing facilities. Rent growth at student housing facilities, on average, has been more modest over the past decade than that of the broader multifamily rental market, likely a result of significant supply growth and cost-pressures on students (and their parents) from tuition and fee inflation. Interestingly, the "list" price of college has risen by nearly 6% per year since 1993, but the "net" cost for the average student after accounting for scholarships and tax subsidies has risen at a more modest 2.4%, barely above the broader rate of inflation. This reflects an increased burden placed on taxpayers and middle-to-upper income families but has likely also increased access to traditional four-year universities to lower-income students, keeping enrollment growth steady despite economic and demographic headwinds.

Bull And Bear Case For Student Housing REITs

The average age of dorm facilities at many universities exceeds 50 years, built for the boomer generation in an era where privacy, connectivity, and amenities in dormitories were afterthoughts. State appropriations to public universities have generally trended down over the past decade as a greater share of state spending goes towards healthcare and other entitlement programs. We think that the on-campus modernization through P3 models is a multi-decade secular tailwind and that universities will increasingly turn towards the private markets to fill this widening funding gap to attract students in an increasingly competitive marketplace.

Over the past decade, student housing REITs have built a stellar reputation as the leaders in student housing development and the stalwarts of the public-private-partnership model. As one of the largest owners and operators of student housing assets in the country, we see significant competitive advantages in the scale and operating efficiencies of ACC's platform. While access to capital hasn't been a factor amid the wide NAV discounts over the past two years, we believe that the REIT model awards ACC with a long-term cost of capital advantage over its private market peers that will be unlocked once again through accretive acquisition-fueled external growth as the company regains its coveted NAV premium. The company pointed out in its recent earnings call that it sees potential acquisition opportunities down the road from recent developers who will be seeking to exit their newly built developments and that ACC can immediately add value to these assets through the efficiencies inherent in its operating platform.

A significant lingering concern for student housing REITs, however, is a negative demographic trend that will continue to put downward pressure on enrollment. The effects of this demographic shift have already been felt in higher education and it has been readily apparent in the fundamentals of student housing REITs. Total college enrollment has been declining since the end of the recession. It's important to note, however, that the decline is concentrated in the "lower-quality" institutions including for-profit schools and community colleges. Below, we see the enrollment trends from the last several years from the National Student Clearinghouse Research Center.

Rising tuition costs, increasingly negative attitudes towards the traditional 4-year model of college education, and a strong labor market have also contributed to the downward pressure on college enrollment. According to a Pew Research poll, nearly 40% of Americans now believe that colleges and universities have a negative effect on the country, up sharply from 27% in 2010. Supply growth remains an overhang on sector fundamentals as development yields remain attractive enough to keep builders building and private capital from institutional investors remains plentiful.

Recent Fundamental Performance

After battling through a series of operational missteps and oversupply issues over the past two years, American Campus appears to have found its mojo once again. First-quarter results were well above expectations as same-store NOI growth surged 5.1% on impressive expense control. The company pointed to cost-saving initiatives including LED lighting upgrades and the renegotiation of cable and internet contracts as drivers of expense reductions. Higher occupancy and improved operating margins appear to reflect improving supply/demand fundamentals in ACC's major markets.

Revenue projections for 2019 fiscal year call for a midpoint of 2.6% growth in rental revenue, an acceleration from the 1.9% rate achieved in FY2018. Expense growth is expected to average 2.7% for the year with same-store NOI growing at 2.5%, up from 1.0% last year, which would be roughly on-par with projections across the broader REIT sector.

Disciplined capital allocation, along with the broader REIT Rejuvenation of 2019, has erased the NAV discount that had stifled the company’s external growth ambitions. With an improved cost of capital and expense growth finally under control, Core FFO growth is finally projected to reaccelerate this year to 4% growth, which would be the best year since 2014.

While still trading at a modest NAV discount by our estimations, it appears that the company is beginning to look into re-opening the acquisition pipeline which has been dormant for the past several years. On this quarter's earnings call, CEO Bill Bayless highlighted that the company is at its best when it's in acquisition-mode and is able to put its operating efficiencies to work to create shareholder value. The company sees long-term opportunity to acquire product from recent developers seeking to exit their investment.

When this company was really producing earnings per share is when we're in M&A activity where we've got 200 to 400 basis points of occupancy and operational efficiencies that we can bring to bear along with rental rate economics over the initial investment period. And so, I think, those days are ahead of us, again, 36, 48 months on the horizon, but there's going to be more opportunity in that arena than we've ever had before.

Ground-up development has historically been the modus operandi and growth engine for the student housing sector. Development yields have compressed in recent years from over 9% to a range of 6.25-6.8% in the last update from ACC, but given the continued compression in capitalization rates, the development spreads remain highly accretive and attractive for new development. ACC noted that development yields are 175 to 275 basis points above capitalization rates in their markets. According to data from Real Capital Analytics, capitalization rates continued to compress modestly in 2018 and are now roughly on-par with the broader REIT sector average.

Attractive development yields are, of course, a double-edged sword, prompting new supply growth into the sector. Rising supply and slowing enrollment growth in key university markets continue to be the story across the student housing sector. While 2018 saw a decline in supply growth, early signs so far in 2019 point to flat or a modest reacceleration in supply growth. As a percent of total enrollment, ACC sees 1.4% growth in new supply in their markets in 2019 which is roughly in line with the historic average, but up from 1.2% in 2018. According to a report from Newmark Knight Frank, supply growth is expected to reaccelerate modestly this year with roughly 46k units under construction.

Elevated supply growth has kept student housing rental rate growth below that of the apartment sector over the past half-decade. American Campus achieved 1.9% revenue growth in 2018, below the 2.6% rate in the apartment sector. ACC sees a modest acceleration in revenue growth this year, however, to 2.6%, still below the average guidance from the apartment REIT sector of 3.0%.

Recent Share Price Performance

After two years of disappointing share price performance, American Campus outperformed the broader REIT average in 2018, returning nearly 5% compared to a 4.6% dip in the broader REIT index. The 5% total return made the student housing sector the fifth-best performing out of the fourteen REIT sectors, just behind the 7% gain in the cell tower sector.

The strong performance has continued into 2019 with the company jumping another 14% this year, respectable performance amid the broader "risk-on" rally given the defensive nature of the sector. A component in the Hoya Capital US Housing Index, American Campus has, however, trailed the nearly 20% gain in the housing industry benchmark, which has been led this year by the homebuilding and home furnishings sectors.

Valuation Of Student Housing REITs

Compared to the other REIT sectors, student housing REITs still appear cheap across all three metrics. Student housing REITs trade at a free cash flow (aka AFFO, FAD, and CAD) discount to the REIT average and appear attractive in the FCF/Growth metric. As we stated above, the sector trades at an estimated 0-10% discount to NAV, far better than the 20%+ discount it traded in early 2018. We expect the external growth pipeline to re-open as the cost of equity capital improves further.

Dividend Yield And Payout Ratio

Based on dividend yield, American Campus ranks towards the upper-end, paying an average yield of 3.9%. Student housing REITs pay out roughly 80% of their available cash flow, leaving enough capital to deploy towards new development and, once the cost of capital improves further, towards external acquisitions.

Interest Rates & Student Housing REITs

Generally seen as a defensively-oriented sector, student housing REITs have historically been more "bond-like" than the typical REIT, but the degree of interest rate sensitivity has decreased over recent quarters. The short tenant lease terms and above-average growth potential result in a level of interest rate sensitivity that is roughly on-par with the REIT average, while the degree of equity market sensitivity is among the lowest in the REIT sector.

Bottom Line: ACC Is Playing The Long Game

After battling through a series of operational missteps and oversupply issues over the past two years, American Campus appears to have found its mojo once again. Disciplined capital allocation, along with the broader REIT Rejuvenation of 2019, has erased the NAV discount that had stifled the company’s external growth ambitions. FFO growth is finally projected to reaccelerate to the strongest rate since 2013.

While short-term fundamentals remain uninspiring, we remain confident in the long-term secular growth story rooted in the much-needed modernization of the physically and functionally outdated university housing stock. Enrollment growth is expected to remain flat-to-lower over the next decade, however, and the attitudes towards the traditional 4-year-model of college education are shifting amid a backdrop of robust economic growth.

While risks related to slowing enrollment growth and still-elevated levels of supply growth remain, we are optimistic on the long-term secular growth story related to the modernization of the physical and functionally outdated student housing stock. As ACC noted on its earnings call, the company is at its best when it's in M&A mode and able to put its operational efficiencies to work. Its recent capital allocation reflects a level of disciple and patience that makes it clear that the company is playing the long game. Another quarter or two of solid results should restore investor confidence - and the coveted NAV premium - that will allow the acquisition pipeline to reopen and let the competitive advantages inherent with the REIT structure finally go to work.

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Analyst’s Disclosure: I am/we are long ACC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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