Why Student Housing Is Making the Grade

Will Baker, Managing Director, Walker & Dunlop. Image courtesy of Waker & Dunlop

Across the U.S., the student housing market is surging. Fannie Mae and Freddie Mac recorded their highest-ever lending volume for the category in 2016, and development is on the rise, as well. New players have entered the field, ranging from conventional multifamily players to large pension funds and private equity investors.

On the supply side, developers delivered about 43,000 new beds last year, representing a 20 percent year-over-year increase. The trend is continuing this year as sales maintain a record pace, and market players expect the strong performance to continue into 2018.

Opportunities and Challenges

Student housing development has specific requirements, as proximity to campus is typically a must for attracting the top rental rates and occupancy that ensure maximum return on investment. Many players feel that the prime locations have been thoroughly picked over, and that potential development sites are limited. However, this trend is opening up potential for projects in smaller campus areas and tertiary markets that offer both strong enrollment growth and a wide choice of development sites.

With competition for land heating up, construction costs on the rise, banks underwriting loans more strictly and some markets turning to later leasing cycles, the student housing market presents its share of challenges. However, these hurdles breed opportunity to find yields in alternative areas and markets, as well as to drive new ways of incentivizing student populations and maximizing rental rates and absorption.

Financing Trends

Since the November 2016 election, Treasuries have continued to rise and spreads have compressed significantly. Interestingly, this environment has left cap rates largely untouched while also squeezing some returns.

Some common financing products include:

• Debt service escrow for deals that close in the spring and summer, which consists of a one-time escrow calculation based on lease-up numbers as of May and June. Once occupancy is confirmed in the fall, funds are returned to the borrower.
• Also gaining traction are forward rate locks, which allow borrowers to lock in rates in the spring and close deals in the fall when paying residents start generating revenue. Going this route carries added cost, because borrowers hedge risk for a current rate and hold the burden of ensuring that the property leases up as planned.
• CMBS lenders have been more competitive but have still offered wider pricing in the student housing space during the past three months than Agency spreads. That provides opportunities for borrowers in smaller markets where Fannie Mae and Freddie Mac are less likely to get involved.
• Life insurance companies also continue to grow their participation in this category. However, their preference for maximum leverage of 65 percent tends favor major metros, like Phoenix (home of Arizona State University) rather than smaller college markets like Knoxville, Tenn., or Lubbock, Texas.
• Balance sheet lending continues to be a significant source of capital, typically taking the form of non-recourse bridge loans for deals not ready for permanent debt or properties that are being leased up or are in transition.

Bullish Outlook

While occupancy and rent trends for fall 2017 remain to be seen, current signs suggest increasing opportunities for growth. However, the number of new beds will likely decrease slightly in 2018 and 2019.

While the rise in online courses raises questions about the impact on enrollment in four-year institutions, this does not appear to be a factor or a replacement for the traditional college experience. Also, the so-called student loan bubble that caused some fears about the future of student housing investment does not appear to be affecting assets, thanks largely to parental guarantees.

With cap rates in the low- to mid-5 percent range for core product within walking distance of campus, expected rise gradually in 2017, along with T-bills, development of higher-density, urban properties will likely continue. These would largely incorporate ground-floor retail, as well. A bullish approach is still the order of the day in student housing, as investors capitalize on growth opportunities as well as on innovative options for financing and deal structure.

Will Baker is a managing director at Walker & Dunlop with more than 15 years of experience in multifamily finance. He originates loans nationwide, with a focus on manufactured housing and student housing properties. During his career, he has originated more than $5 billion in Agency financing, including over $1.4 billion in 2016, which placed him at the top of the company’s rankings. He holds a bachelor’s degree in economics from Washington & Lee University.