Student Housing: Higher education, lower grade?
The strength of the UK student housing market has attracted institutional investors for some time. But, asks Rachel Goult, could the sector be about to weaken?
Spurred by competition among higher education institutions, private investment in UK university accommodation continues unabated. Of course, the quality of campus facilities, especially accommodation, has become more important for students. The need for universities to either maintain or move up university league tables has made accommodation a promising asset class.
However, there could be reason for caution. Recent regulatory changes to higher education – to tuition fee levels and the cap on eligible students – has intensified competition among the UK’s top universities, especially in light of recent decline in UK and EU student applications. This is a trend we believe might continue and could negatively affect accommodation projects at smaller universities.
It seems that long-term investors regard UK university accommodation as an interesting opportunity. Knight Frank, the UK real estate consultancy, has reported that the country’s university accommodation attracted £3.1bn (€3.4bn) of financing last year – with 56% of funds originating from domestic investors. The figure is down from £5.1bn invested in 2015, but is more than double the figures from 2013 and 2014. And the transaction flow is likely to continue.
What is behind investors’ interest in student accommodation? We believe it comes from the need to diversify portfolio risk in light of the relatively predictable cash flow and resilience against market downturns.
Student accommodation offers long-term (up to 45 years) investments that provide a hedge against inflation, on account of these bonds characteristically being index-linked, and a guarantee of repayment from monoline insurers. Typically, revenue streams are backed by long-term contracts that transfer credit and rent collection risk – and, to some extent, occupancy risk – to the university. And this exposes lenders to the institution’s creditworthiness rather than the tenant’s.
£3.1bn was invested in UK university accommodation in 2016
Meanwhile, there are substantial incentives for universities to regenerate student accommodation. With today’s students paying more attention to the student experience when choosing a university, the quality of accommodation plays an important role. The quality housing options (along with student satisfaction) is also a consideration for university league tables. And so the need to improve or build new accommodation is presenting private investors with an opportunity to step in.
But could demand fall? Data from the Universities and Colleges Admissions Service (UCAS) suggests a potential slowdown in demand for university places, which is likely to last for another two years. The 3.7% decrease in applications for the upcoming academic year (as of June 2017) follows flat demand growth in the 2016-17 academic year.
Precipitating the decline in applications is a combination of factors: the drop in demand for nursing places (a 12,400 drop in applications in absolute terms) due to changes in the tuition fee system and; a decline in UK applications that could, in part, be linked to an improving employment market for 18-25-year olds. Looking ahead, apprenticeship schemes and online distance learning could also provide alternatives to higher education, thereby limiting demand for accommodation. And with demand falling, rental prices in privately financed accommodation could rise. Temporary shocks, such as uncertainty for non-UK nationals around labour laws post-Brexit and rising tuition fees, are making it hard to estimate how many students will apply for university in the coming years.
What does this mean for occupancy levels – and, in turn, project risk? In short, the outlook appears unchanged for the country’s higher-ranked institutions, but it paints a markedly different scene for lower-ranked universities.
The removal of compulsory minimum-grade requirements has significantly altered the ratio between applications and acceptances. Despite the intensifying competition among universities for the highest-calibre students, the university system – although oversubscribed – may see its surplus between offers and acceptances begin to shrink. This may not negatively affect the more prestigious institutions, but it may pose risks for accommodation occupancy levels in the lower echelons of the country’s league tables, whose ability to service debt would weaken as a result.
With this in mind, university accommodation as an asset class might experience some uncertainty as demand for it becomes similarly less predictable in the years ahead.
Rachel Goult is a director at Global Infrastructure Ratings, S&P Global Ratings