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Student Housing Investment Sales Activity Grinds to a Halt

Higher interest rates have created a bid-ask gap between student housing buyers and sellers, shutting down sales activity in the market.

Business is booming for student housing managers. Properties are full for the 2022-2023 school year and rents are rising more quickly than ever for pre-leases for 2023-2024.

But investors in purpose-built student housing are not willing to pay higher prices, despite higher rents. Instead, they demand steep discounts because of rising interest rates. Many potential sellers are unwilling to cut prices while others are unwilling to even offer properties for sale given the state of the market.

"The volume of deals is less than projected,” says Frederick Pierce, president and CEO of Pierce Education Properties, an owner and manager of student housing properties based in San Diego.

“The Fed’s raising of interest rates is causing many buyers of all types of commercial real estate to temporarily step back."

Volume of deals shrinks

Dealmaking for student housing properties ground to a halt this fall, after a very busy spring.

“2022 started as a record year for the sector,” says William Vonderfecht, senior vice president of national student housing CBRE. Investors spent more to buy student housing properties in the first and second quarters of 2022 than they had in the same periods of 2021, 2020 or 2019, according to data from CBRE. Over the 12 months that ended October 2022, student housing investors spent more than $25 billion, according to data firm MSCI, based in New York City. That’s more than three times higher than the average volume of investment in prior 12-month periods. The massive $13 billion purchase of American Campus Communities by Blackstone boosted the overall total, but individual properties also sold in large numbers earlier this year.

The boom in property sales stopped with higher interest rates.

“This fall, which is historically the sector’s busiest season, sellers brought fewer assets to market,” says Vonderfecht. “We expect the fourth quarter will also fall short of recent years.”

Student housing rents are higher than ever

Many are buying fewer student housing properties even though the proven income from those properties is rising quickly. Students are already rushing to sign new leases for the 2023-24 school year at sky-high prices.

“Fall 2023 is off to a blistering start,” says Carl Whitaker, director of research and analysis for RealPage Inc., headquartered in Richardson, Texas. “We’re hearing rumblings of huge demand levels from students electing to renew and lock in leases early for next year.”

As of the end of November 2022, roughly a quarter (25 percent) of student housing beds had already pre-leased for 2023-24, according to RealPage. That about five percentage points higher than the previous record for November pre-leasing. Also, effective rents for these preleases are averaging more than 8 percent higher than a year ago.

“The student housing sector is just now experiencing the historic rent growth that the multifamily sector experienced in 2020 and 2021,” says CBRE’s Vonderfecht.

These student housing properties already recovered from the pain of the coronavirus pandemic. A record 96.3 percent of student housing beds were occupied for 2022-23 and effective rents grew more than 4 percent compared to the year before, beating the previous record for rent growth, according to RealPage. In contrast, during the Fall 2021-22 school year, a significant number of students did not even sign up for classes—or student housing—because of the coronavirus pandemic. Just 87 percent of beds were occupied—the lowest occupancy rate on record, according to RealPage. Rents still grew, but by just 0.4 percent on average.

Student housing rents continue to rise partly because developers opened just 30,000 new student housing beds for 2022-23—the smallest number in more than a decade, says Whitaker. Developers are on track to open 20 percent fewer new beds for 2023-24 and 2024-25 than the average for the previous five years. This despite enrollment at many universities jumping higher as student swarmed back to campus for in-person classes and many campuses accepted more students than usual, says Whitaker.

High interest rates chill the market for property sales

But high rents are not enough to get potential buyers to pay high prices. They may not accept that occupancy rates can stay this high—and many are most concerned with the cost of financing.

“Interest rates are the central focus for both buyers and sellers,” says Vonderfecht.

Federal Reserve officials have increased their benchmark interest rates several times this year in an attempt to cool down the overheated U.S. economy and slow prices inflation. The Fed’s increases have pushed the 30-day Secured Overnight Financing Rate (SOFR) from close to zero to 380 basis points, as of early December.  As a result, the spreads lenders charge for non-recourse loans have widened from 150-to-200 to 350-to-425 basis points, says Pierce.  That works out to a variable interest rate of 7.30 percent to 8.05 percent. That means that potential buyers must budget for higher costs for debt service. They also have to make do with smaller loans—often cover less the 60 percent of the value of a property—and often have to contribute more equity to their purchases.

“The dramatic rise in interest rates not only increased debt payments, but significantly cut proceeds in some instances,” says CBRE’s Vonderfecht. Rising rates also make the cost of floating-rate interest rate caps prohibitive for many buyers.

Some buyers are making deals work by assuming the existing debt of the properties they buy. “Investors’ demand for assuming in place financing is like nothing we’ve seen in years,” says Vonderfecht. “Previously, investors would have only offered on the assets on a free-and-clear basis given the flexibility and customization available by placing new financing.”

For example, CBRE arrange the sale of a portfolio of student housing properties that had financing in place with a limited term remaining. “More than 70 percent of the assets are being acquired as loan assumptions,” says Vonderfecht.

Some investors are betting interest rates will not stay high. “I don’t believe debt terms will stay this onerous for very long, but current terms can work for value-add deals that are priced right with a two- or three-year business plan and subsequent sale or refinance,” says Pierce.

Properties sell for less—if they sell at all

When buyers and sellers can agree on prices for student housing, those prices are significantly less than they have been.

"We have heard from investment sales brokers that inflation and the related increases in interest rates has brought student housing valuations down about 10 percent from 2021 pricing,” says Pierce. “Would-be sellers have either pulled their properties from the market or been willing to proceed with a valuation adjustment or expectation."

Pierce Education Properties has taken advantage of lower prices to buy four student apartment communities this year including at Clemson University and University of Georgia and has two more in escrow. 

“All are value add investments where our team and our investors could clearly see the NOI and value growth through strategic renovations and rent growth,” says Pierce. “With lesser competition for acquisitions in the current market, we are able to secure much better pricing that can support higher interest rates for the shorter-term duration of our planned investment period.”

The uncertainty about how high interest rates will rise may also be creating an opportunity for private investors. “In periods of uncertainty we see institutional capital sources pull back until waters calm,” says Vonderfecht. Many foreign investors have also dropped out of the bidding for student housing properties as the U.S. dollar strengthens against other currencies.

“Private investors that were beat out on opportunities by institutions and foreign investors over the last few quarters are now regaining traction,” says Vonderfecht. “There are great buying opportunities for nimble investors in the market today.”

Correction: December 13, 2022
This article has been updated to clarify some comments and figures.
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