The diversification benefits and economic resilience of student housing are helping the sector to become an established part of institutional portfolios. Ian Scott looks at the development of the market in the UK
As a real estate asset class, student accommodation has attracted increasing attention in recent years, not least because of the healthy returns that can be generated and the compelling underlying market fundamentals of ever-increasing student numbers.
With the introduction of significantly higher university fees for students from the next academic year, questions have been raised over the outlook for this sector and the impact that the requirement for far higher investment from students will have.
Growth in student numbers has been extraordinary over the past 10 years. In 2010 there were 2.49m students in the UK, of which 1.63m were full time. This represents a 28% growth in student numbers since 2000, with student participation increasing to more than 40% of school-leavers. Demand for places greatly exceeds supply, with roughly 30% of university applicants rejected.
The UK government is now implementing radical changes to the funding of higher education, shifting more of the burden directly to the student and reducing central funding to universities. While an environment of academic funding cuts suggests future growth in student numbers will be more constrained, demand for higher education remains strong. This is reflected in the number of overseas students, which has grown by 37% over the past 10 years to 340,000 in 2009-10, or 10% of global international students, a level that is second only to the US.
The fundamental attractions of the UK as a centre for learning for international students, based on the language and reputation of higher education institutions, are not affected by the funding changes, as these students already pay full fees and many currently enjoy an attractive exchange-rate differential.
Since international students will not be affected by fee changes, markets with a higher exposure to foreign students should feel the effects significantly less than others. London is the biggest market for international students in the UK, and will therefore remain a key market for investors and developers in the sector.
In addition to the expected ongoing demand from students for accommodation, particularly in top-tier university locations, the outlook for net new supply to the market adds to the attraction of the sector.
While new development and capital expenditure from universities is focused on refurbishing or replacing existing space, rather than creating any net new space, private sector development remains limited due to the capital restraints of many operators in the sector and the ongoing lack of debt available for new development. Those with existing high-quality assets are likely to benefit for some time.
In this more competitive environment, the need for universities to meet the demand from a more ‘commercially aware' customer - by providing improved teaching and infrastructure - will become acute. Increasingly, universities will need to focus on financial returns and the customer service that will drive those returns as central funding declines. This new environment provides opportunities for investment by the private sector in both student accommodation and universities' wider estates, as institutions look to leverage in capital to attract students in a competitive global higher education market.
Overall, while we expect:
• The full-time/part-time student mix to change;
• More ‘stay-at-home' students (the trend over the past 10 years);
• Shorter, more intensive, courses (with consequential increases in occupation).
We also expect:
• The core customers (and their parents) to continue to value the university experience and qualifications;
• The demand for education and accommodation to become more discerning in quality and value terms (this will lead to a two-tier market, with the highest demand for places at universities offering the most compelling overall higher education offer);
• The quality of the academic estate to become an increasing consideration for students in the university selection process because of the increased fee structure.
If the higher education sector funding outlook is uncertain, the immediate economic background is also changeable, but the lack of correlation with other asset classes and the wider economy is one of the reasons we remain attracted to the higher education sector.
While in tough economic times low growth should be expected, the general trend over almost 30 years is for student rents to rise overall at a rate above the retail price index (RPI).
This is well ahead of commercial property in the long term, and that growth is both more stable than, and not correlated with, commercial property rent growth. Analysis also shows that low inflation is generally good for real growth in student rents, despite the effect it can have on the wider real estate market.
Can this persist? While the customer base is smart and seeking good value, there are three factors at work that suggest it can.
• We are, on average, talking about relatively small annual rises. There is no five-year rent review ‘shock' to a tenant;
• The customer base is aspirational, skewed towards the top quintile socio-economic groups, and has a three-year ‘memory'. They are consciously investing in education, albeit with a largely unquantified expected return on that investment;
• The RPI factor is a useful, if imperfect, ‘anchor' for most people, but is arguably the wrong index to use. Instinctively, wage inflation would appear more useful as students anticipate the increased earning power higher education affords.
While it would be wrong to suggest that the UK student housing sector has been unaffected by recession, it has been remarkably resilient relative to the rest of the UK commercial property market. The reasons for that resilience, along with the lack of correlation with other property assets types, provide a strong argument to include at least a representation of student accommodation in a balanced portfolio on the grounds of performance as well as diversification.
These factors are now fuelling institutional investor appetite for a sector that is becoming firmly established. These investors appreciate that the central thesis of good risk-adjusted returns with strong defensive characteristics has been proven. In particular, they are attracted by strong occupational demand, the absence of large expensive voids, low risk of bad debts and good rental growth prospects.
Over the past couple of years, most of the new investment into the UK student accommodation market has come from foreign equity and sovereign wealth funds. However, UK institutions are beginning to recognise student housing as a credible asset class, which is welcome given the scarcity of debt in the market generally. Investment will continue to be channelled towards schemes where demand is considered secure and, crucially, to established and successful operators.
Ian Scott is a fund manager at Quintain