This is the second article in a four-part series highlighting student housing as a real estate asset class. The first article, “Educational Overview: Student Housing vs Multifamily Housing,” is live.

Student housing has come a long way in a relatively short period. Less than two decades ago, this commercial real estate sector was highly fragmented, poorly understood and minimally tracked. The assets consisted either of off-campus apartments offered to students or older residences with multiple bedrooms.

Thanks to the fundamentals of student housing and more professional developments, the sector is finding more favor with institutional investors. They’re funding construction and buying the properties. These days, more institutional capital has found its way into the sector, with the highlight being Blackstone’s $13 billion acquisition of American Campus Communities Inc.

Experts tell Connect CRE that even with commercial real estate challenges, student housing is coming out of it reasonably well. “Over the last five years, student housing has evolved into an institutional asset class, impacting sector strategies across the board,” commented Mitchell Korte, executive vice president with Subtext. “These include financing and construction, along with resident demand and rent growth.”

The Fundamentals: Overall Demand and Supply

COVID-19 sparked fears of vacant student housing properties due to stay-at-home mandates. But Student Quarters Chief Acquisition Officer Andrew Layton pointed out that students remained in place even while campuses shut down. They didn’t want to go home and potentially infect the family. So “they stayed and flourished. We didn’t see occupancy dips during this period. In fact, we came out on the other side stronger than ever.”

As mentioned in a previous article, the fundamentals examined by student housing buyers and builders involve college enrollment. As such, “campus housing has largely been insulated from the economic slowdown since just about every campus in the U.S. is facing some degree of student housing shortage,” explained Eric Gould, senior project manager and student housing expert at Project Management Advisors Inc.

Meanwhile, Korte indicated that enrollment continues to increase, especially at the more popular flagship schools. “We’re seeing rents continue to grow year-over-year in nearly every market,” he added. “Students want to be close to campus and are willing to pay for the location, amenities and security that institutional projects can provide.”

Sean Baird, Colliers senior vice president and leader of the International Student Housing Group, agreed, adding that demand for the product is escalating and outpacing supply in many markets. “This means higher occupancy rates and robust rental rate growth,” he explained.

Meanwhile, the experts acknowledged that the pipeline and construction starts have tapered off since the halcyon pre-COVID days. One reason is that, like other CRE sectors, construction in student housing is beset with higher materials and labor costs. “Construction costs have increased in concert with cost increases for multifamily,” explained Brent Little, president of Fountain Residential Partners.

Though reduced supply and increased demand can jump-start rent growth, Parker Champion cautioned that rent growth and high enrollment alone don’t lead to great student housing decisions. Barriers to entry are also considered. For example, markets like Austin, TX, have attracted much institutional capital. However, “the low barriers to entry have given us pause about investing there,” said Champion, COO and partner with Champion Real Estate Company. “We look at the development pipeline, both private and university-driven. A supply/demand imbalance should exist to support demand for our investment.”

So, Just How Interested Are Investors?

Perhaps unsurprisingly, investment in the sector fell in 2023 relative to the previous year due to the same factors impacting other commercial real estate sectors, Specifically, unpredictability in the face of rapid increases in interest rates.

Layton with Student Quarters indicated that, overall, the student housing sector is healthy. But on the other side, the buyer-seller expectation gap facing other CRE sectors also exists here. “A lot of these properties were valued before the rising interest rate environment,” Layton pointed out. “The sellers have developed lofty expectations about the value of their properties. So what’s happening is the great disconnect between buyers who have to achieve certain returns in a rising interest-rate environment and sellers’ expectations from values given to them in the years before that.”

Furthermore, current owners are hanging onto their properties because of the abovementioned fundamentals. Noted Forest Residential’s Little: “Most sellers this past year looked at the rental-rate increases that have been achieved and elected to hold their assets for another year to grow the value.”

This doesn’t mean there is absolutely no interest from buyers. Layton indicated that overseas investors continue demonstrating interest and “a healthy appetite to deploy capital into this space.” Korte noted that the sector attracts considerable increased investor interest because of its ongoing rent growth, especially when compared to multifamily, which has been either flat or negative. PMA’s Gould pointed out that interest is also increasing in the sector, primarily due to the aging supply of existing campus housing that lacks modern amenities.

Along these lines, Baird explained that investor interest in 2023 focused on flight to quality in the “Power Five” markets – mainly the prestigious, better-known, state-funded and state-run institutions. Furthermore, while universities with strong enrollment growth and limited supply continue to be targeted by investors, “emerging Tier 2 markets growing to over 20,000 students are catching the eye of many investors,” Baird said. “The return profile here continues to be above Tier 1 markets because of the perceived riskier investment.”

Though investment activity was below 2022 levels due to the cost of capital and capital markets disruption, the experts noted that the strong rent growth in specific markets allowed investors to underwrite higher rent growth and obtain positive leverage, especially relative to traditional multifamily. “The lack of safe, modern housing continues to fuel previously unseen levels of rent growth and occupant demand,” Gould observed. “This, in turn, helps deals to pencil despite the increased cost of debt.”