Student Housing – More On Tap
I “found” some financial data lying on a barstool in a college bar. I promise you, the goods are good. Asking price: $5,000. Here’s a taste. If you like it, you can crank open the report and search all the nooks and crannies for even better stuff.
• Same store NOI growth grew 6% over the same quarter last year
• Current projected rental rate increase of 2.2 percent over current year rates
• Same store wholly-owned occupancy 96.2 percent as of March 31, 2010
Before my door gets kicked-in by New York’s finest, I’ll fess-up. No, this isn’t from 2007. This astounding performance is courtesy of American Campus Community’s (NYSE:ACC) most recent quarterly financials. As the largest owner/operator in the space, ACC serves as the bellwether of the industry. With that said, most owner/operators are reporting that their leading indicators are pointing toward a strong 2010-2011 academic year.
The student housing market has been relatively unfazed by the Great Recession. Universities often serve as the main economic driver of their local communities, which is fortunate given that universities rarely close their doors and never relocate for tax abatements. Although most industry insiders have been comfortable with the industry’s fundamentals for quite some time, the past two years have been marked by uncertainty. The following questions were nauseatingly frequent this time last year:
• How are parents going to send their kids to school when they lose their jobs?
• What happens when students can’t get student loans?
• State universities are facing slashed budgets – won’t they be forced to cut enrollment?
• How can you possibly raise rental rates when mom and/or dad are out of a job?
• How are you going to refinance at maturity?
Much like a fat kid in a bakery, everything just fell into place. Judging by the numbers, most parents have been able to still send their kids to school. Anecdotal evidence suggests that institutions with more affordable tuition rates may have benefited from the nation’s economic malaise. After the private student loan market fell apart, the federal government stepped-in. Enrollment has held steady. Universities found various ways to reduce expenses without having to touch the holy grail of enrollment. Rental rates are artificially market driven and haven’t been overly affected by the general economy. Even for those in the industry, the question/answer sessions just weren’t fun.
Most operators are reporting average occupancy between 93% and 98%. Leasing for next year is much stronger at this point than it was this time last year. Both rental rates and leasing velocity are ahead of last year’s performance. Collection loss continues to average between 1-2% for most operators. A number of new ground-up development student housing projects are currently under construction. Both balance-sheet lenders and Freddie/Fannie remain active in the space. Neither Freddie nor Fannie is reporting any student housing loan defaults. Transactional volume is poised to grow exponentially over the next 18 months as industry fundamentals portend a bright future.
One may question how transactional volume can increase so rapidly given the current state of the credit markets. Credit is the oil that lubricates the machine, after all. There is no-shortage of capital in the markets right now. Lenders are simply incredibly risk-averse. Enter student housing. Due to the strong fundamentals outlined above, relatively few defaults and even fewer foreclosures across the country, the space remains envied. Furthermore, the few problem loans out there are simply a derivative of over-leverage and other capital-stack related challenges.
Both Fannie Mae and Freddie Mac have designated student housing programs. Some small balance sheet lenders also remain active in the space. Given general risk aversion, the market can be bifurcated into two segments; loans under $25m and those above $25m. It remains challenging to originate and/or refinance a loan with a principal balance greater than $25m. The brain damage involved with structuring a club-deal is very often not worth the headache. Credit availability remains stronger for deals less than $25m and even stronger for smaller deals under $15m. Balance sheets and sponsor qualifications are subject to intense scrutiny. Credit is flowing but is only flowing to the top 25% of borrowers. Below is a general outline of what one can expect for a stabilized deal:
• 70-80% LTV
• 5, 7, 10 year terms
• 25-30 year amortization
• 1.25-1.35 DSCR (market dependant)
• Rates between 5.85%-6.75%
Construction loans are entirely relationship dependant and balance sheet driven. If a developer is unsure of where to find construction financing, he or she should holster their shovel.
Although the above referenced loan terms sound enticing, one can expect a proctologist like level of scrutiny. The following hot-buttons are deal makers or killers:
• Location: A property further than a mile from campus can be a tough sell. There are exceptions, however. In-demand product such as “cottage style” student housing is often exempt from the ‘spitball from campus’ test.
• Seasoning: a strong trailing 12 months is critical for a refinance. Collection loss, occupancy, etc will be carefully examined. On an acquisition, don’t expect a lender to buy into proforma rent. Lenders will underwrite to seasoned, in-place rent. The GSEs in particular would love to do more acquisition related financing.
• SREO: Lenders expect to see a strong borrower. There should be few if any problems in the borrower’s portfolio. Any problems and/or potential problems must be mitigated by liquidity. Expect for liquidity verification. The days of “I really have $10m floating around under my mattress” are long over.
• Sponsor: Experience is paramount. Although one can argue whether lenders have a bias toward owner/operators or third party managers, it is essential that the party responsible for managing the asset has years of hard-earned experience. Student housing can be brutal in that leases coincide with the commencement of the academic year. If a property fails to lease-up, there is little that can be done until the next academic year. Lenders are aware of this and price their student housing loans accordingly. Spreads and DSCRs tend to be higher for student housing than for multifamily as a whole.
• Amenities: Lenders are wary of amenity poor properties. Given that lenders have no upside and only downside, most lenders want to ensure that their sponsors have the tools to ward off new competition, etc. Make sure the pool is fully stocked with babes.
• Risk mitigation: Lenders are especially concerned with physical risk and loss. Insurance policies, operation and maintenance (O&M) plans, etc are examined in detail.
• The Kosher Factor: Most lenders expect (rightfully so) that deals and sponsors are completely kosher. If a lender smells pork, he or she is going to run instead of asking for an explanation.
Student housing remains one of the few attractive sectors left standing. For the right sponsor with the right deal, the credit markets are relatively open.
Oliver E. Swan
Chief Investment Officer
145 Madison Avenue
New York, NY 10016
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