Guest comment: Time for some student revision?

The UK student accommodation sector is facing headwinds, writes Hayley Scott of Investec Structured Property Finance.

Almost 2 million students descended on UK universities last month. While they enjoy those optimistic first few weeks, investors and developers in the student accommodation sector also have positives to focus on.

“Scratch below the surface, and there are headwinds” Hayley Scott, Investec Structured Property Finance.

Yields in the strongest locations look set to sharpen. Savills expects investment volumes to reach £5.3 billion (€6 billion) in 2017, a 17 percent increase on 2016, marking a return of investor confidence after the EU referendum. Overseas investors continue to pay premiums.

But scratch below the surface, and there are headwinds. The longer-term effects of Brexit and other macro events aside, potential challenges face the sector – with an impact on both borrowers and lenders.

Construction prices could be a cause for concern. What were reasonable costings 18 months ago may be creeping up, with the number of sub-contractors leaving Britain post-Brexit rising, leading to significant labour shortages, and the ever-weakening pound pushing up the cost of materials.

The result for tight schemes could mean noticeably less profit and/or delayed delivery projections, with students naturally loath to commit to part-built projects, unless there is little alternative.

Operators face challenges as well. In 2014 the number of privately owned beds available was around 100,000. This year that figure will be close to 250,000, an increase of 150 percent. Filling beds, managing assets and driving up rents to deliver targeted yields across growing portfolios will require established purpose-built student accommodation operators to reconsider their strategies.

The threat to student numbers is coming from several angles. Government policy on immigration; the colossal all-in cost of the university experience; the UK losing its position as the epicentre of postgraduate research; and schools encouraging top pupils to forgo university for apprenticeships and vocational courses.

Recent figures from the Universities and Colleges Admissions Service (UCAS) show applications from EU school-leavers to British universities have declined by 5 percent following last year’s referendum. Students need a good return on their university investment. Savills predicts that average annual graduate earnings increase £930 for each 20 UCAS points. For that reason, places such as Manchester, London, Bristol and Bath offer longer-term development potential – where the university is highly regarded but, similarly, where land is in short supply due to the strength of the residential market, driving rental growth and yield compression.

At the other end of the spectrum, several purpose-built student locations are approaching saturation, leaving developers’ assumptions on rental growth – to make their schemes viable – increasingly unrealistic.

Despite the sector’s challenges, Investec lent more than £100 million into it in H1 2017. While lenders need to dig a bit deeper when looking at new projects, the sector’s defensive, stable characteristics, attractive yield and the seemingly insatiable demand from Chinese students for a British university experience, mean student accommodation remains attractive from a debt perspective.

GIC and Maple Tree’s recent heavy investment demonstrates investors taking advantage of the currency depreciation to pay premiums on well-run and well-located portfolios. This makes sense – acquiring immediate scale, on favourable yields, for stable assets offering longer-term alternative use potential.

But foreign investors will always need to convert currency back. Historically low interest rates look increasingly fragile. Any increase will not only further impact development, but tempt investors away from property towards bonds or other asset bases.

It is difficult to say whether this is the top of the cycle for UK student accommodation. What is apparent is that the rate of sector growth is being challenged. Rents cannot continue going up to mitigate land overpayment, especially if student numbers continue to trend downwards.

Lenders need to take a more forensic approach to deal analysis and the local market. We are not significantly changing how we structure loans or their terms but we are going further than examining the traditional supply/demand dynamics.

For instance, will the affordability for student renters be sustainable, especially when considering inflation-linked rents going forward, and with strong competition in most university towns? The design of the building should also be more of a consideration than ever before, as more affordable clusters take centre stage and more expensive studios fall out of favour. And, clearly, the track record of both the developer and the capabilities of the operator are now crucial.

White knight investors may keep the sector afloat, driven by the hunt for yield, to pay premiums to establish themselves. But it is likely that only the most adept developers and operators – those able to operate at lower margins – can expect to be beneficiaries. The bell could be tolling for smaller market players, and those backing secondary and tertiary schemes face an uncertain future.