Since last year, there’s just one publicly-traded player left in the student housing sector. For better or worse, when the privately owned Greystar acquired EDR, it left a single competitor standing.
As such, our Hoya Capital Student Housing Index is tracking the lone entry REIT, American Campus Communities (ACC).
Accounting for $6.5 billion in market value, American Campus owns roughly 110,000 of the more than 5 million purpose-built U.S. student housing beds available. Naturally, its portfolio is primarily comprised of on-campus or near-campus facilities at major four-year public universities.
More about them soon enough. For now, let’s look at the “larger” sector American Campus Communities occupies…
Student housing is essentially a microcosm of the trends seen across the REIT sector for the last four years. In other words, it’s been gobbled up by the private markets.
Both private domestic and international investors alike can appreciate a defensively-oriented and counter-cyclical real estate asset. And so they are, pursuing the significant value that student housing properties have to offer. Thanks to their efforts, capitalization rates are on-par or even below their apartment peers now.
A record $11 billion of capital flowed into the sector in 2018, according to Newmark Knight Frank. And, overall, the sector has quickly emerged from a niche business into a full-fledged institutional marketplace.
Though they do also offer development, consulting, and management services to university partners, real estate ownership accounts for student housing REITs’ primary revenue source. As would be expected. And, to be sure, they’re among the most active developers in the REIT sector.
When it comes to creating real estate-based value, they utilize several different models. American Campus, for one, (told you we’d get back to it) has a number of value-creation levers to pull. The most profitable of these models is the public-private partnership.
This is employed when a university in need of new dorms doesn’t have the capital to build one. So it leases land to a REIT instead, which then builds, owns, and manages the facility… complete with an almost guaranteed steady flow of renters. The university, for its part, gets an annual ground-lease rent check without deploying any capital. And the students get a new dorm. A win-win-win for all.
ACC calls this partnership the ACE Plan, and its implementation accounts for roughly a quarter of the company’s total revenue.
The other three-fourths of revenue typically come from traditional private, off-campus units, sometimes in partnership with a university. These are generally more exposed to supply/demand imbalances and changes in university housing policies. Generally speaking, the closer a facility is to campus, the higher the barrier to entry.
They’re also less exposed to oversupply or other idiosyncratic risks, making them preferable in just about every way.
Purpose-built student housing facilities are generally cheaper. More attractive still, they’re equipped with more applicable amenities for students than typical off-campus housing facilities. Rent growth at student housing facilities, on average, has been more modest over the past decade than that of the broader multifamily rental market. This is likely a result of significant supply growth and cost pressures on students from tuition and fee inflation.
Bull and Bear Case for Student Housing REITs
The average dorm facility at many universities is 50 years or older… built for Baby Boomers in an era where privacy, connectivity, and amenities for such students were afterthoughts. And over the last decade, state funding for universities has generally trended down, believe it or not. A greater share of spending now goes toward healthcare and other entitlement programs, pushing higher education down on the hierarchy.
This and other reasons lead us to believe that universities will increasingly turn toward the private markets. They don’t have much other viable, cost-efficient choice if they want to attract students in an increasingly competitive marketplace.
Over the past decade, student housing REITs have built a stellar reputation as the stalwarts of the public-private partnership model. And ACC being one of the largest owners and operators of student housing assets in the country, it has significant competitive advantages.
Admittedly, access to capital hasn’t been a factor amid the wide net asset value (NAV) discounts over the past two years. Yet we believe that the REIT model awards ACC with a long-term cost of capital advantage over its private market peers. This should be unlocked again through accretive, acquisition-fueled external growth as the company regains its coveted NAV premium.
In its recent earnings call, ACC pointed out that it sees potential acquisition opportunities down the road. Recent developers, it appears, will be wanting to exit their newly built developments, whereas ACC can immediately add value to those assets through the efficiencies inherent in its operating platform.
A significant lingering concern for student housing REITs – ACC included – is a negative demographic trend that will continue to put downward pressure on enrollment. The effects of this shift have already been felt in higher education… and it’s readily apparent in associated REITs’ fundamentals as well.
Total college enrollment has been declining since the end of the recession, though that fall is most felt in “lower-quality” institutions. This is mostly defined as for-profit schools and community colleges, yet it’s still important to keep in mind
Below, we can see the enrollment trends from the last several years from the National Student Clearinghouse Research Center.
Rising tuition costs, increasingly negative attitudes toward traditional college educations, and a strong labor market have all contributed to the downward pressure. According to a Pew Research poll, nearly 40% of Americans now believe that colleges and universities have a negative effect on the country. In 2010, that figure was only 27%.
With all that said, supply growth does remain an overhang on sector fundamentals. Development yields remain attractive enough to keep builders building, and private capital from institutional investors is still plentiful.
Recent Fundamental Performance
Back to ACC in particular, it battled through a series of operational missteps and oversupply issues for two years. But it appears to have found its mojo once again. First-quarter results were well above expectations, as same-store NOI growth surged 5.1% on impressive expense control.
The company implemented a number of cost-saving initiatives, including LED lighting upgrades. Plus, it renegotiated cable and internet contracts as drivers of expense reductions. Higher occupancy and improved operating margins also appear to reflect improving supply/demand fundamentals in ACC’s major markets.
Revenue projections for the 2019 fiscal year call for a midpoint of 2.6% growth in rental revenue. This is an obvious acceleration from the 1.9% rate it achieved in 2018. Expense growth, meanwhile, is expected to average 2.7% for the year, with same-store net operating income (NOI) growing at 2.5%. That would amount to a 1% year-over-year increase and put it roughly on-par with projections across the broader REIT sector.
Disciplined capital allocation – along with the broader REIT rejuvenation of 2019 – has erased the NAV discount that had stifled the company’s external growth ambitions. With an improved cost of capital and expense growth finally under control, core fund from operations (FFO) growth is finally projected to re-accelerate this year to 4%.
In that case, it would be ACC’s best year since 2014.
While still trading at a modest NAV discount by our estimations, it appears the company is beginning to look into expanding again after several years of shelving such projects. On this quarter’s earnings call, CEO Bill Bayless highlighted that ACC is at its best when in acquisition-mode. In short, management sees long-term opportunities to acquire products from recent developers seeking to exit their investments.
“When this company [is] really producing earnings per share is when we’re in M&A activity, where we’ve got 200 to 400 basis points of occupancy and operational efficiencies that we can bring to bear along with rental rate economics over the initial investment period. And so, I think, those days are ahead of us. Again, 36, 48 months on the horizon, but there’s going to be more opportunity in that arena than we’ve ever had before.”
Ground-up development has historically been the modus operandi and growth engine for the student housing sector. Development yields have compressed in recent years from over 9% to 6.25-6.8% in ACC’s last update. But given the continued compression in capitalization rates, the development spreads remain highly attractive for new development.
ACC noted that development yields are 175-275 basis points above capitalization rates in their markets. And, according to data from Real Capital Analytics, capitalization rates continued to compress modestly in 2018. They’re now roughly on-par with the broader REIT sector average.
Now, attractive development yields are, of course, a double-edged sword. Rising supply and slowing enrollment growth in key university markets continue to be the story across the student housing sector… hence the reason why 2018 saw a decline in supply growth.
So far in 2019, early signs point to flat or modest re-acceleration in supply growth. As a percent of total enrollment, ACC sees 1.4% growth in new supply in their markets in 2019. That’s roughly in line with the historic average, but up from 1.2% in 2018. Plus, according to a report from Newmark Knight Frank, supply growth is expected to re-accelerate modestly this year, with roughly 46,000 units under construction.
American Campus achieved 1.9% revenue growth in 2018 and expects to see a modest acceleration this year to 2.6%. As noted before, that’s below the apartment sector’s average, but that’s a trend across the student housing board.
Bottom Line: ACC Is Playing the Long Game
So here’s the bottom line… After battling through a series of operational missteps and oversupply issues over the past two years, American Campus appears to have found its mojo once again. Disciplined capital allocation, along with the broader REIT rejuvenation of 2019, has erased the NAV discount that had stifled the company’s external growth ambitions. And FFO growth is finally projected to re-accelerate to the strongest rate since 2013.
While short-term fundamentals remain uninspiring, we’re confident in its long-term growth story. Universities need what ACC can offer to modernize the physically and functionally outdated university housing stock they’re working with right now.
Yes, risks related to slowing enrollment growth and still-elevated levels of supply growth remain. We’re not ignoring those. But as ACC noted on its earnings call, it’s at its best when it’s in mergers and acquisitions (M&A) mode and able to put its operational efficiencies to work.
Its recent capital allocation reflects a level of disciple and patience that makes it clear it’s playing the long game. Another quarter or two of solid results should restore investor confidence – and its coveted NAV premium – and allow the acquisition pipeline to reopen. That way, the competitive advantages inherent with the REIT structure can finally go to work.
I am/we are Long ACC
Alex Pettee, CFA, is the founder and president of Hoya Capital Real Estate, an SEC-registered investment advisor that is working to make real estate investing more accessible for all. Originally conceived as part of a capstone master's thesis at Georgetown, Hoya Capital Real Estate advises ETFs and individual accounts by investing in portfolios of publicly traded commercial and residential real estate companies.
A dual-degree holder and two-sport athlete at Georgetown, Alex played baseball and track for the Hoyas, and studied Finance and Real Estate at the McDonough School of Business. A CFA charterholder, Alex remains head of ETFs for Hoya Capital Real Estate.