Will Brexit affect student numbers and hurt the appeal of the sector in the UK? Not necessarily, say Joanna Turner and Rocco Versace
In a post-Brexit vote environment, investors in the UK property market are increasingly looking for defensive ‘safe haven’ investment opportunities to protect portfolios against any upcoming economic uncertainty and potential increases in market volatility.
Student housing offers many of the defensive characteristics investors are looking for. This has been borne out by recent activity. There was approximately £3.1bn (€3.7bn) invested in the UK purpose-built student accommodation market in 2016, making it the second highest year on record after the exceptional 2015, when 74,500 beds were traded at a total value of £5.9bn.
Although this still only represented around 7% of the total £44bn invested in UK commercial property last year, it has seen exceptional growth since 2010 – when only £500m was invested.
The sector has also been a stellar performer. The CBRE Student Accommodation index outperformed the MSCI benchmark over the 12-month period to Q3 2016, showing a total return of 10.2%, compared with the MSCI (IPD) Quarterly UK Property index return of -2.3%.
Given the higher-than-expected investment performance and stable income returns, investor appetite for student housing has never been stronger. But what has driven this extraordinary growth and why is it so attractive to investors? Is it really ‘Brexit-proof’? What about lenders’ appetite for the student accommodation sector?
In an economic environment characterised by ultra-low interest rates, there are many key drivers, including a solid demand base, attractive yields and steady rental and capital growth. There are also diversification benefits resulting from the low correlation between student housing and traditional property sectors. As figure 1 shows, higher rental yields on student accommodation make the sector appear far more attractive on a relative basis than current low bond yields, which have been distorted by monetary policy intervention and quantitative easing. This is likely to remain the case over the next few years.
However, as figure 1 also shows, average student accommodation yields have compressed significantly in recent years, due to increasing investor demand and a shortage of investment-grade purpose-built student accommodation.
Investors targeting income opportunities have seen prime yields in the sector fall by around 40bps over the past two years, due to the fall in bond yields and a flight to safe-haven investments. A good example has been Aviva Investors’ recent £76m acquisition of a forward-funded accommodation building in Coventry, at a reported yield of 4.24%.
With top prime London student accommodation yields now at 4.5%, compared with 3.5% for prime central London office yields, the sector is starting to look keenly priced, particularly considering the additional risk premium required for investing in a less mature sector displaying lower levels of liquidity than the well-established central London office sector. Therefore, investors are increasingly seeking higher yielding opportunities outside the capital.
For example, better value investments can be found in historic and emerging regional locations with excellent education systems, good quality infrastructure and limited supply. Historic towns with restricted supply – such as Oxford and Cambridge – offer yields of about 5.2%, while prime regional cities with mature markets and a healthy supply-demand balance – such as Glasgow, Newcastle and Southampton – offer 5.5%.
Given a recent supply increase across the UK, investors now need to think more broadly about where to invest and how to find value in student accommodation. Investing in cities where universities have plans to grow and/or relocate campuses, as well as looking at cities where the supply-demand balance is favourable, should be key factors.
For instance, Bristol University is planning to invest £300m over the next five years in a second campus, which should be able to accommodate an additional 5,000 students. Another example is Belfast, where Ulster University is building a new campus in the city centre to relocate 12,000 students from Jordanstown.
University towns like Hull, Guildford, Egham, Brighton, Swansea and Norwich could also be interesting investment targets, given the shortage of student accommodation facilities. However, planning constraints, poor official data about the local student population and high residential values are factors to be aware of.
In addition, a key concern for investors is whether the strong demand for student accommodation seen in recent years will continue, given uncertainty about the impact of Brexit on student numbers coming from the EU. There are concerns surrounding immigration controls, a possible introduction of student visas, higher tuition fees and the relatively high cost of study in the UK for foreign students.
While the longer-term picture is still unclear, figures from UCAS, the university admissions centre, suggest that after modest growth in overall student numbers of 1% pa in 2017-18, there is likely to be a decline in EU student numbers. This is expected to be counterbalanced to some extent by a modest increase in non-EU and domestic students, suggesting broadly flat overall student numbers beyond 2018.
Demand from students is expected to be strongest for high- and mid-tariff universities, while a decline is expected for low tariff universities. Overall, it should be sufficient to sustain rental growth ranging from 2% to 3.5% pa in 2017 and 2018. The largest owner/operator, Unite Students, said it is expects rental growth at the top end of these forecasts, with continued full occupancy.
There will be big differences between various cities and regions, as well as weak and strong universities, so investors will need to carry out detailed risk-return analysis and due diligence on target towns and cities and select stock carefully. In general, rental growth forecasts are stronger for regions outside of London, particularly those undersupplied and seeing increasing student numbers.
Until recently, though, there were significant barriers to entry for investors, as it has been a fairly illiquid and fragmented market, dominated by a few specialist owner/operators. Apart from Unite Students, which has 50,000 bed spaces under management, half of the top 30 operators/investors in the UK market, by number of operational beds, have less than 10,000 beds.
However, with Unite recently converting to a REIT, and other major owner/operators now following suit, this will open up new investment opportunities and diversification benefits to smaller, retail investors, while providing greater liquidity to the market.
Additionally, private operators are working with universities to develop new investment products and are creating new operating platforms to compete with the private rental sector. Examples include Vero Living, Liberty Living and Campus Living Villages, as well as Hello Student, a platform set by Emperic Student Property (ESP). These developments are creating more choice for students looking to stay in new, innovative, technology-led community hubs.
Major institutional investors and Sovereign Wealth Funds – such as BlackRock, GIC, GSA and Goldman Sachs – have also been investing recently in major portfolio deals of existing assets and developments in order to acquire scale quickly.
Among the ‘alternative’ property sectors, student housing has been the preferred asset class among lenders, particularly non-bank lenders such as insurers, private equity players and international lenders.
While major UK banks have viewed the sector favourably, they will continue to be constrained by increased regulatory requirements and costs, which are likely to dampen lending. In contrast, insurers will continue to deploy their balance sheets to the sector to diversify their portfolios and gain further exposure to a maturing asset class offering further growth potential and defensive long-term income streams to match liabilities. These institutions are able to offer tailored facility terms to borrowers, meeting a broader level of funding demand.
For example, Canada Life Investments recently provided a £40m loan to premium student accommodation owner/operator ESP – with a loan-to-value of 50%. The loan was secured against four forward-committed assets and completed in time for the 2016-17 academic year. This was the second loan provided to ESP by Canada Life, bringing the total combined loan to the student accommodation investor to £71m, secured against eight assets.
Longer-term debt facilities will become increasingly available in the future. With more attractive lending margins on student housing than on traditional mainstream property assets – ranging from 200bps above LIBOR for low-risk senior debt on existing assets, up to 550bps for a high-risk development, according to property consultant CBRE – the debt market is expected to grow further as the sector matures.
The strong growth in investment activity in the purpose built student accommodation sector seen over the past few years is likely to continue. Investors will continue to be drawn to the sector’s attractive yields, particularly outside London, as well as steady rental and capital value growth, and diversification benefits.
The main risk is on the demand side as a result of the outcome of the Brexit negotiations, with potential future restrictions on visas for EU students. However, the UK is recognised globally for its higher education. Despite short-term uncertainty, the UK is likely to continue to attract a large number of students from around the world, further attracted by the weak pound.
On balance, the future still looks bright for investment and lending in this sector, as it continues to grow and mature as an asset class. However, as always, careful stock selection and detailed due diligence are essential.
This article is part of a series in collaboration with the Society of Property Researchers
Joanna Turner is head of property research at Canada Life Investments, and Rocco Versace is analyst at Avamore Capital