In 1998, Paul Dunlap, president of Dunlap Property Group based in Fullerton, Calif., saw an opportunity to buy and rehabilitate a multifamily property less than a mile from California State University.

After Dunlap spent more than $1 million to rehab nine buildings, his project now commands rents ranging from $950 per month for a one-bedroom to $820 per month for a larger shared bedroom. It was an investment that has paid off threefold.

Today, however, it's hard to find opportunities like the one Dunlap found in 1998. “There is a very astute marketplace out there ready to capitalize,” he says. “So I don't think the diamond in the rough like I found really exists.”

Even so, the sheer demographics make a compelling case for student housing investment. Projections point to a 15% rise in college enrollment among people under the age of 25 between 2005 and 2016, while enrollment among persons age 25 and older is expected to rise 21%, according to The National Center for Education Statistics.

Despite those heady numbers, near-term economic issues are casting a shadow over student housing. Education Realty Trust, one of two publicly traded student housing real estate investment trusts (REITs), reports that occupancy dropped to 93.7% for September in its apartment portfolio, compared with 96.3% for September 2007. In three markets — Oxford, Miss.; Gainesville, Fla.; and Kalamazoo, Mich. — the REIT's leasing was down 13% from the previous year.

After stating initial figures for September, the Memphis, Tenn.-based REIT revised its figures downward when many students who had signed leases did not show up. This caused a leasing decline of 0.7% in the company's core portfolio, and declines of up to 3.7% elsewhere in its portfolio, mainly at properties in Midwestern or Southern states, such as Murray State College in Oklahoma and Jacksonville State in Florida.

Paul Bower, CEO of Education Realty Trust, doesn't believe leasing weakness is entirely due to the sagging economy. “There's a certain amount of softness every year. We were caught off guard in a couple of places. Some of it was probably our own administrative mistake, and some of it could well be economy related,” he concedes.

In a bad economy, people tend to cut back on spending, affecting parents' willingness to co-sign student loans and leases. With the credit crunch, parents are concerned about higher loan costs.

“With the economic downturn, what you could see is state universities being forced to scale back their enrollment growth targets because they are suffering budget constraints from the states, or the universities could change their policies to mandate their students live on campus,” says Paula Poskon, a senior equity research analyst with Robert W. Baird & Co.

A tale of two REITs

Although Education Realty Trust has suffered leasing declines, Poskon points out that American Campus Communities, an Austin-based REIT that manages, develops and owns 86 student-housing properties, actually saw an occupancy gain of 1.1% in September over the same period a year ago.

Returns for the two REITs also are disparate, and may signal that something greater than the economy is at work. For example, Education Realty Trust's total returns were down about 25% year-to-date through Oct. 21, while American Campus Communities' returns were down by about 1% over the same period. There are also concerns about Education Realty Trust's ability to refinance some $400 million in debt that is coming due next year.

It might be easy to conclude from Education Realty Trust's leasing decline that something is wrong in the sector and economic weakness is starting to show. But American Campus' high occupancy seems to indicate a more market-specific condition, says Poskon of Robert W. Baird & Co.

In two of Education Realty Trust's stressed markets — Oxford, home of the University of Mississippi (UM), and Gainesville, home of the University of Florida (UF) — the problem is that the older properties are competing with new supply, says Bower.

Even though Education Realty Trust's properties in Oxford and Gainesville are only six to seven years old, “college students do gravitate to what's brand new.” So as new supply comes onto the market, existing properties lose occupancy.

In addition, enrollment at UM and UF is flat. In Kalamazoo, where Western Michigan University (WMU) is located, enrollment has fallen significantly, says Bower. While WMU enrollment rose 1.6% this fall, the increase followed a decline of 18% between 2002 and 2007, according to the university.

It's all about location

Jared Schenk, an operating partner with Chicago real estate investment firm Gem Realty Capital, says that these days the best opportunities in student housing are infill projects in well-located communities close to major universities.

Properties in prime markets characterized by stable and growing student enrollment with less scope for building, such as those surrounding the University of California in Los Angeles or Arizona State University in Tempe, are likely to perform best.

In contrast, second-tier markets that offer ample vacant land for building, like Tallahassee, home of Florida State University, or third-tier markets where rents tend to be even lower, such as the home of Texas State University in San Marcos, don't fare as well. Moreover, monthly rents range from as little as $200 per bed in third-tier markets to $1,600 per bed in primary markets.

“It has always been hard to find infill land close to campus, which is the art in terms of finding the right deal to do,” Schenk says. “The easiest way to do it, the path of least resistance, is ‘Where can I find the largest piece of land within a radius of five miles?’”

This approach worked when there was less competition several years ago, but waves of development brought projects closer to campus, with better amenities.

Back to financing basics

In addition to supply problems, student housing, like other commercial real estate property sectors, faces challenges in arranging financing for projects. When the commercial mortgage-backed securities market dried up, no other source stepped in to pick up the slack.

Fannie Mae and Freddie Mac dominate the niche's financing, with commercial banks a distant second. For the first half of the year, Fannie Mae provided $264 million in financing for student housing properties, double its volume for the first half of 2007. In addition, earlier this year Freddie Mac launched a dedicated student housing mortgage, which allows for underwriting on a nine-month lease, since student housing leases typically factor in the summer months.

Lenders now require more equity investment from buyers, with loan-to-values hovering in the 65% to 70% range, compared with 80% to 85% during the last couple of years, says Linwood Thompson, a managing director with Marcus & Millichap's multihousing group.

Construction financing for student housing projects is less available and more expensive, since most of the loans are floating-rate debt tied to LIBOR (London Interbank Offered Rate).

Since August 2007 when the credit crunch began, interest rates for construction loans have been priced at LIBOR plus up to 300 basis points. Before August 2007, however, construction loans were priced at LIBOR plus up to 150 basis points. “There is probably more desire to develop than there is the practical ability to develop right now,” Thompson notes.

Meanwhile, the cap rate differential on student housing is 75 to 100 basis points higher than on other multifamily properties, such as apartments and condominiums, since investors expect a higher return, Thompson says.

Cap rates on student housing properties averaged about 7.5% at the end of the second quarter, up from 6.7% in the same period a year ago. In contrast, cap rates on multifamily properties rose to 6.3% at the end of the second quarter this year from 6.15% a year earlier.

On Class-A properties in prime markets, student housing cap rates are up about 25 basis points over last year. And investors are now adding premiums of as much as 100 to 125 basis points to Class-C properties in the least desirable markets.

“Student housing is a little more complicated to manage,” Thompson notes. “Therefore, there are fewer people qualified to manage it. Some investors view it as just too risky.” While the leasing season takes place over six months, the residents move in during a three-week period in August or September. Operators must be careful not to make mistakes in leases they might have to live with for a year.

Doing more with less

With construction costs up, there also is more emphasis today on buying and renovating existing multifamily properties. These products hold more appeal for older students than freshmen and sophomores, Thompson says.

Developers can also forge partnerships with universities by entering into long-term leases for well-located land. In such cases, the developer manages the property and then returns it to the university when the lease ends.

This helps universities struggling with state budget cuts. And it also makes more economic sense for universities to outsource student housing development and focus on their core competency of providing education.

In one such partnership, American Campus Communities this summer opened Vista Del Sol, a 1,866-bed project at Arizona State University in Tempe. The property features amenities such as a resort-style swimming pool and a 50-seat theater, which have proven popular with students. Rents range from $500 per bed to $1,000 per bed. The REIT has a 99-year lease on the land.

Under pressure

How will the ongoing economic downturn affect the niche? Thompson forecasts that rent growth will slow, but he doesn't expect vacancies to rise. “The heat could come out of the fire a little bit. It is increasingly difficult for students to get loans and there is pressure on people to double up or stay at home,” he notes. Still, Thompson expects student housing to weather the storm with relative ease.

People are “laser focused” on watching the preleasing season for the academic year 2009 to 2010, which runs from November to February, says Poskon of Robert W. Baird.

Still, investors appear enthusiastic. Even as transaction activity for other multifamily property types was off 6% at about $80 billion through mid-2008 from a year earlier, student-housing deal volume actually rose by 1% to $2.5 billion, reports Real Capital Analytics. However, that figure includes a major deal in which American Campus Communities acquired GMH Communities Trust for more than $1 billion.

And there is more room for consolidation in student housing. For now, Education Realty Trust, American Campus Communities, and privately held Philadelphia-based Campus Apartments control about 5% of the fragmented market.

In a downturn, more people tend to head back to school to become more marketable. Some students even decide to extend their stay at universities or enroll in graduate school, rather than battle a weak job market.

Whether such factors will be enough to buffer the sector remains to be seen. “We've been through bad economies before,” laments Bower, “but I don't know that anyone has been through anything like what we're going through right now.”

Poonkulali Thangavelu is senior associate editor.

TOP STUDENT HOUSING DEALS

The biggest student housing property transaction for the 12-month period ending Sept. 30 was the $275 million sale of Gramercy Green, a 304-unit property in New York. The price was more than three times the size of the next-largest acquisition. Following is a list of the top five deals.

Property Location Sale Price Buyer Seller Price Per Unit
Gramercy Green New York $275 million New York University J.D. Carlisle Development Corp., Credit Suisse $904,605
Cabana Beach Gainesville, Fla. $73.8 million Campus Advantage, LaSalle Investment Management FortGroup $146,329
University Estates Austin, Texas $51.5 million Preiss Co., HSBC Capital USA Inc Falcon Southwest, Cargill Value Investment $103,414
Grand Marc at University Village Riverside, Calif. $45 million Kayne Anderson Rudnick Investment Management LLC American Campus Communities, GMH Communities Trust $212,264
Campus Lodge Lutz, Fla. $42.6 million Campus Advantage, LaSalle Investment Management FortGroup $136,499
Source: Real Capital Analytics
American Campus Communities At a Glance
Headquarters: Austin, Texas
2007 Annual Revenue: $147 million
Stock Symbol: NYSE (ACC)
Stock Price (Oct. 23): $25.74
52-Week High: $37
52-Week Low: $23.18

Portfolio: The self-managed REIT owns 86 student housing properties totaling 52,800 beds. The company also owns a minority interest in 21 joint-venture properties containing 12,100 beds.

Source: Company reports, MarketWatch

In two of Education Realty Trust's stressed markets — Oxford, home of the University of Mississippi (UM), and Gainesville, home of the University of Florida (UF) — the problem is that the older properties are competing with new supply, says Bower.

Even though Education Realty Trust's properties in Oxford and Gainesville are only six to seven years old, “college students do gravitate to what's brand new.” So as new supply comes onto the market, existing properties lose occupancy.

In addition, enrollment at UM and UF is flat. In Kalamazoo, where Western Michigan University (WMU) is located, enrollment has fallen significantly, says Bower. While WMU enrollment rose 1.6% this fall, the increase followed a decline of 18% between 2002 and 2007, according to the university.

It's all about location

Jared Schenk, an operating partner with Chicago real estate investment firm Gem Realty Capital, says that these days the best opportunities in student housing are infill projects in well-located communities close to major universities.

Properties in prime markets characterized by stable and growing student enrollment with less scope for building, such as those surrounding the University of California in Los Angeles or Arizona State University in Tempe, are likely to perform best.

In contrast, second-tier markets that offer ample vacant land for building, like Tallahassee, home of Florida State University, or third-tier markets where rents tend to be even lower, such as the home of Texas State University in San Marcos, don't fare as well. Moreover, monthly rents range from as little as $200 per bed in third-tier markets to $1,600 per bed in primary markets.

“It has always been hard to find infill land close to campus, which is the art in terms of finding the right deal to do,” Schenk says. “The easiest way to do it, the path of least resistance, is ‘Where can I find the largest piece of land within a radius of five miles?’”

This approach worked when there was less competition several years ago, but waves of development brought projects closer to campus, with better amenities.

Back to financing basics

In addition to supply problems, student housing, like other commercial real estate property sectors, faces challenges in arranging financing for projects. When the commercial mortgage-backed securities market dried up, no other source stepped in to pick up the slack.

Fannie Mae and Freddie Mac dominate the niche's financing, with commercial banks a distant second. For the first half of the year, Fannie Mae provided $264 million in financing for student housing properties, double its volume for the first half of 2007. In addition, earlier this year Freddie Mac launched a dedicated student housing mortgage, which allows for underwriting on a nine-month lease, since student housing leases typically factor in the summer months.

Lenders now require more equity investment from buyers, with loan-to-values hovering in the 65% to 70% range, compared with 80% to 85% during the last couple of years, says Linwood Thompson, a managing director with Marcus & Millichap's multihousing group.

Construction financing for student housing projects is less available and more expensive, since most of the loans are floating-rate debt tied to LIBOR (London Interbank Offered Rate).

Since August 2007 when the credit crunch began, interest rates for construction loans have been priced at LIBOR plus up to 300 basis points. Before August 2007, however, construction loans were priced at LIBOR plus up to 150 basis points. “There is probably more desire to develop than there is the practical ability to develop right now,” Thompson notes.

Meanwhile, the cap rate differential on student housing is 75 to 100 basis points higher than on other multifamily properties, such as apartments and condominiums, since investors expect a higher return, Thompson says.

Cap rates on student housing properties averaged about 7.5% at the end of the second quarter, up from 6.7% in the same period a year ago. In contrast, cap rates on multifamily properties rose to 6.3% at the end of the second quarter this year from 6.15% a year earlier.

On Class-A properties in prime markets, student housing cap rates are up about 25 basis points over last year. And investors are now adding premiums of as much as 100 to 125 basis points to Class-C properties in the least desirable markets.

“Student housing is a little more complicated to manage,” Thompson notes. “Therefore, there are fewer people qualified to manage it. Some investors view it as just too risky.” While the leasing season takes place over six months, the residents move in during a three-week period in August or September. Operators must be careful not to make mistakes in leases they might have to live with for a year.

Doing more with less

With construction costs up, there also is more emphasis today on buying and renovating existing multifamily properties. These products hold more appeal for older students than freshmen and sophomores, Thompson says.

Developers can also forge partnerships with universities by entering into long-term leases for well-located land. In such cases, the developer manages the property and then returns it to the university when the lease ends.

This helps universities struggling with state budget cuts. And it also makes more economic sense for universities to outsource student housing development and focus on their core competency of providing education.

In one such partnership, American Campus Communities this summer opened Vista Del Sol, a 1,866-bed project at Arizona State University in Tempe. The property features amenities such as a resort-style swimming pool and a 50-seat theater, which have proven popular with students. Rents range from $500 per bed to $1,000 per bed. The REIT has a 99-year lease on the land.

Under pressure

How will the ongoing economic downturn affect the niche? Thompson forecasts that rent growth will slow, but he doesn't expect vacancies to rise. “The heat could come out of the fire a little bit. It is increasingly difficult for students to get loans and there is pressure on people to double up or stay at home,” he notes. Still, Thompson expects student housing to weather the storm with relative ease.

People are “laser focused” on watching the preleasing season for the academic year 2009 to 2010, which runs from November to February, says Poskon of Robert W. Baird.

Still, investors appear enthusiastic. Even as transaction activity for other multifamily property types was off 6% at about $80 billion through mid-2008 from a year earlier, student-housing deal volume actually rose by 1% to $2.5 billion, reports Real Capital Analytics. However, that figure includes a major deal in which American Campus Communities acquired GMH Communities Trust for more than $1 billion.

And there is more room for consolidation in student housing. For now, Education Realty Trust, American Campus Communities, and privately held Philadelphia-based Campus Apartments control about 5% of the fragmented market.

In a downturn, more people tend to head back to school to become more marketable. Some students even decide to extend their stay at universities or enroll in graduate school, rather than battle a weak job market.

Whether such factors will be enough to buffer the sector remains to be seen. “We've been through bad economies before,” laments Bower, “but I don't know that anyone has been through anything like what we're going through right now.”

Poonkulali Thangavelu is senior associate editor.

TOP STUDENT HOUSING DEALS

The biggest student housing property transaction for the 12-month period ending Sept. 30 was the $275 million sale of Gramercy Green, a 304-unit property in New York. The price was more than three times the size of the next-largest acquisition. Following is a list of the top five deals.

Property Location Sale Price Buyer Seller Price Per Unit
Gramercy Green New York $275 million New York University J.D. Carlisle Development Corp., Credit Suisse $904,605
Cabana Beach Gainesville, Fla. $73.8 million Campus Advantage, LaSalle Investment Management FortGroup $146,329
University Estates Austin, Texas $51.5 million Preiss Co., HSBC Capital USA Inc Falcon Southwest, Cargill Value Investment $103,414
Grand Marc at University Village Riverside, Calif. $45 million Kayne Anderson Rudnick Investment Management LLC American Campus Communities, GMH Communities Trust $212,264
Campus Lodge Lutz, Fla. $42.6 million Campus Advantage, LaSalle Investment Management FortGroup $136,499
Source: Real Capital Analytics
American Campus Communities At a Glance
Headquarters: Austin, Texas
2007 Annual Revenue: $147 million
Stock Symbol: NYSE (ACC)
Stock Price (Oct. 23): $25.74
52-Week High: $37
52-Week Low: $23.18

Portfolio: The self-managed REIT owns 86 student housing properties totaling 52,800 beds. The company also owns a minority interest in 21 joint-venture properties containing 12,100 beds.

Source: Company reports, MarketWatch