REIT Rankings: Student Housing
In our REIT Rankings series, we introduce and update readers each of the residential and commercial real estate sectors. We focus on sector-level fundamentals, analyzing supply and demand conditions and macroeconomic factors driving underlying performance. We update these reports quarterly with a breakdown and analysis of the most recent earnings results.
Student Housing Sector Overview
Within the Hoya Capital Student Housing Index, we track the lone student housing REIT, American Campus Communities (ACC) which accounts for $6.4 billion in market value. Once viewed as a riskier asset class than traditional apartment REITs, the sector has matured over the last decade, no doubt helped by the robust demand for student housing associated with the enormous millennial generation. 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.
Down to just one major player after the acquisition of EDR by Greystar in 2018 and the Harrison Street acquisition of Campus Crest Communities in 2015, the student housing sector comprises 1% of the broad-based REIT ETFs (VNQ and IYR). 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, but we see a potential reversal of that trend given the REIT Rejuvenation this year which has restored the critical NAV premium for most REIT sectors, a critical prerequisite for accretive acquisition-fueled external growth. Student housing REITs have historically been one of the most countercyclical real estate sectors as student enrollment trends are typically inversely correlated with job growth.
Purpose-built student housing facilities are generally cheaper and are equipped with more applicable amenities for students than typical off-campus housing facilities. Compared with their conventional multifamily peers, student housing typically assets operate at lower margins due to increased costs associated with leasing and more frequent turnover, but save on lower property taxes as some on-campus facilities (as part of a University partnership) are exempt from property taxes. Student housing facilities are generally rented "by-bed" rather than "by-unit" and there is generally a much shorter "leasing window," as beds that are unfilled at the start of the school year are likely to sit vacant until the next school year. Student housing assets, especially off-campus units that are not part of a University partnership, are also exposed to changes in University housing policies that can result in significant asset impairment.
Rent growth at student housing facilities, on average, has been more modest over the past decade due to declining (or negative) enrollment growth and significant supply growth in purpose-built student housing. The millennial generation - the largest cohort in American history - supported the maturity of the student housing industry over the last decade into a mainstream institutional-grade real estate sector. At 23 years old, the youngest of the millennials are now out of college and entering the workforce and beginning to come full-steam in the undersupplied housing markets. While that is good news for the rest of the residential REIT sectors, it's not great news for the student housing sector. The prime college-aged population is expected to see 0-1% population growth over the next decade.
Despite these headwinds, student housing REITs are still perhaps the most “recession-resistant” REIT sector. Concerns regarding rising tuition costs are overstated by the widening gap between “sticker prices” and net costs. 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.
Student Housing REITs are among the most active developers in the REIT sector and utilize several different models to create value. The most attractive of these models, we believe, 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. In part due to its large development pipeline, American Campus operates at leverage levels slightly above its multifamily peers but maintains an investment-grade credit rating.
Student Housing Fundamental Performance
Following a strong first quarter in which same-store NOI growth surged 5.1% on impressive expense control, second-quarter earnings were generally seen as a step backward. Same-store revenues rose 3.2% while NOI rose 3.5%, squarely in-line with the broader apartment REIT average. Occupancy rose 220 basis points to 90.6% while operating margins ticked up 10 basis points year-over-year. As discussed, margins for student housing assets are generally significantly below those of the conventional multifamily sector. After battling through a series of operational missteps and oversupply issues over the past two years, American Campus' fundamentals appear to have stabilized, but supply growth continues to keep a lid on potential growth.
Most disappointing to investors who were expecting a boost to guidance this quarter, full-year guidance was maintained in 2Q as the company projects that revenues will rise 2.6% for the full-year with NOI growth of 2.5%, which implies a deceleration into the end of the year. Rent growth is expected to rise by 2.3% this school year compared to the 3.8% blended rent growth achieved by the apartment REIT sector in the past quarter.
Elevated supply growth has kept student housing rental rate growth below that of the apartment sector over the past half-decade. Overall, student housing fundamentals are lagging the conventional multifamily sector, but note that student housing comparable metrics have historically been less volatile than their apartment REIT peers. As we will discuss in more detail below, slowing enrollment growth also continues to be a headwind for the sector.
The company also maintained full-year core FFO per share guidance. 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. 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.
Speaking of supply growth, 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 a report from Newmark Knight Frank with 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 Newmark Knight Frank, supply growth is expected to reaccelerate modestly this year with roughly 46k units under construction. Axiometrics data also shows that supply growth in 2019 is expected to be roughly consistent with 2018 before tailing off into 2020 based on currently planned projects.
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. Despite being viewed as the most recession-resistant real estate sector, however, the sector has underperformed this year on concerns over continued supply growth and uninspiring demand growth. After jumping 14% through the first four months of 2019, the sector has treaded water and is higher by 12% this year, the third worst-performing REIT sector. A component of the Hoya Capital Housing Index, ACC has lagged the nearly 26% YTD gains on the housing industry benchmark.
Valuation Of Student Housing REITs
Compared to the other REIT sectors, student housing REITs still appear cheap across most valuation 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.
Student Housing REIT Dividend Yield
American Campus pays a dividend yield of 4.0%, ranking towards the upper-end of the REIT sector average. 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
Student housing REITs are perhaps the most “recession-resistant” REIT sector based on past correlations with movements in interest rates and the broader equity market. While the large development pipeline of American Campus has added some "beta," student housing REITs have historically been one of the most "bond-like" REIT sectors, responding more closely to movements in long-term interest rates (IEF) than movements in the S&P 500 (SPY).
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. Below we discuss the five reasons investors are bullish on the student housing sector.
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. Consistent with the countercyclical characteristics of student housing demand, male enrollment has been especially weak over the last five years. 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. Below we outline the five reasons that investors are bearish on the student housing sector.
Bottom Line: Millennials Have Grown Up
The millennial generation - the largest cohort in American history - supported the maturity of the student housing industry over the last decade into a mainstream institutional-grade real estate sector. At 23 years old, the youngest of the millennials are now out of college and entering the workforce and beginning to come full-steam in the undersupplied housing markets.
For the student housing sector, growth has been harder to come by over the last half-decade. Enrollment growth, even at the highest-quality institutions, has been flat-to-down since 2012. Meanwhile, supply growth continues to be a headwind for the sector as capital remains plentiful. Off-campus units are also highly exposed to changes in university housing policies.
Despite these headwinds, student housing REITs are perhaps the most “recession-resistant” REIT sector. While we don't believe a recession is imminent, we do view ACC as a hedge against an unexpected downturn in economic growth. While risks related to slowing enrollment growth and still-elevated levels of supply growth remain, we remain optimistic on the long-term secular growth story related to the modernization of the physical and functionally outdated student housing stock and like American Campus' high-quality portfolio of on-campus and near-campus facilities.
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Disclosure: I am/we are long VNQ, ACC. 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.
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