High returns make sector the top alternative choice in Europe, reports Doug Morrison.
When prime property looks expensive, alternative asset classes start to look attractive and the European real estate industry is at the tipping point.
In the Emerging Trends in Real Estate Europe, 2016 survey of over 550 leading property professionals by PwC and the Urban Land Institute, 41 percent of respondents say they are thinking of investing in such sectors this year, up from 28 percent in 2015. Student housing is top of the wish list.
The research suggests a combination of higher yields and sustainable income returns is drawing investors to student accommodation, followed by hotels and healthcare.
Another key reason is diversification of investment, say many interviewees and respondents, who bemoan a shortage of prime property at reasonable prices. This is the flip side of the wall of capital bearing down on European real estate.
Says one Dutch fund manager: “Pricing of core real estate is too high, so the way around it is to be more creative and active in the value-added and opportunistic space and also niche sectors like elderly care, student housing and self-storage.”
Such sectors also occupy the top spots in Emerging Trends Europe’s investment prospects rankings for 2016. Student housing, hotels and healthcare are expected to outperform mainstream commercial real estate. What would be considered non-core real estate takes up eight out of the top 10 places.
For UK investors more than Continental ones, student housing is rapidly evolving from niche play to mainstream asset class. The latest research follows remarkable levels of activity, with most agents putting investment volumes at £5.7 billion for 2015 – more than twice the previous record – consolidating the UK’s position as the leading market for purpose-built student accommodation outside the US.
In fact, investment volumes exceeded those of the US for the first time – an extraordinary fact given that the US student population is 10 times greater than the UK’s.
Overseas institutions move in
The UK figures were boosted by major overseas institutions striking portfolio deals to enter the market, such as Canada Pension Plan Investment Board’s £1.1 billion deal for the 16,800-bed Liberty Living brand. Leading US operator-investor Greystar Student Living consolidated its position with a £1.1 billion outlay on two portfolios.
James Kingdom, Bilfinger GVA’s lead researcher, says up to a third of private beds were on the market at one stage last year, reflecting a spike in investment volumes. He believes that this year the market will settle to around 2014 levels of £1.7 billion, but will stay on course for steady, long-term growth.
In its August 2015 interim financial statement, leading UK operator Unite highlighted this level of activity’s effect on asset prices. The group’s average portfolio yield stood at 5.8 percent at the end of the first half of 2015, down 47 basis points from December 2014. Unite predicts further yield compression in the next 18 months as a result of higher investment volumes.
Few, if any, predict yield compression for core UK property. Kingdom says student accommodation has provided domestic and overseas institutions with an important way to diversify as prime commercial real estate starts to look not only costly but restrictive – the average office lease lasts seven years.
“They still hanker for a nice 25, 30-year income that in theory rises every year, in some way index-linked. That gives something along the lines of an annuity product.”
Kingdom adds: “If you time student housing right and make the right acquisition, you can get a decent foothold in the market in a very quick period of time.”
Investors also get access to a student population of about 2.3 million – down from 2.5 million in 2011-12 just before tuition fees were introduced – and the prospect of big growth following the removal of the cap on UK and EU students permitted to study at UK universities. Unite says this will result in at least 100,000 additional students attending university in the coming years and has generated strong demand for accommodation in the 2015/16 academic year.
As important is the inexorable rise of non-EU international students – up 42 percent to 310,700 since 2004-05, according to the Higher Education Statistics Agency.
All of which, in theory, should benefit the main student accommodation types: the direct-let model based on assured shorthold tenancies; and long-lease investments based on nomination agreements with universities guaranteeing the rent, usually index-linked.
Roger Lown, senior director and national head of student housing at Bilfinger GVA, says the riskier, direct-let model is akin to the hotels star system, with students as guests, expecting a level of service to match what they pay for. Arguably, location is even more important here than for other asset types, almost down to the street or block. The trick is to get as close to campus as possible.
Lown says: “If your product is in the right location, it should do well. But just because it’s badged student accommodation doesn’t mean it will do well. If you’re a mile from the campus that’s a mile where a competing scheme can steal your students.”
He adds: “There’s a lot of risk to do with supply and demand. In some cities we’ve seen considerable new supply, so there might be oversupply if all the schemes with planning permission are built.”
In that respect, Lown has “concerns” about Newcastle and Liverpool, but adds that if proposed schemes are perceived to be in the “wrong” locations they will struggle to raise finance, especially from institutional investors, which “are very risk-averse; they want ticks in lots of boxes”.
One leading UK institution in this area is M&G Real Estate, which has invested nearly £1 billion since 2009 in universities and student housing, across equity capital and debt through public bonds. M&G has invested in inflation-linked, long-lease agreements as a liability-matching exercise for its pension clients.
Returns beat speculative offices
Investment director Kris McPhail says the group is also invested in direct-let assets and has backed specialist developers such as Watkin Jones. “If you invest in certain markets where you’re comfortable with the supply-demand dynamics you’re probably getting a better return, year on year, than a spec office scheme,” he says.
M&G’s exposure is all in the UK, but McPhail says it is considering investing in less-established Continental student housing markets. “I think the sector will keep growing. There is increasing interest and investment from outside the UK, particularly the US, so some UK funds that took the plunge five or six years ago may sell out because they’ve made their returns.
“When they went in they were probably seeking double-digit returns. Now you’re probably going to get single-digit returns.”
As McPhail suggests, the risk is very “asset specific”. Though oversupply may be an issue in some cities, in others McPhail and Lown warn of constrained supply because of rising tender prices, compounded by stringent planning regimes imposing Community Infrastructure Levy payments as a block on development.
“There is a nervousness in certain towns and cities that rents could become unaffordable [for students],” says McPhail, who also stresses the importance of operational management. “If an operator takes its eye off the ball or you aren’t thinking of future-proofing your offering, your occupancy numbers may struggle; then you have to reduce your rate to manage occupancy, which has an impact on returns.”
The sector nonetheless remains attractive to M&G, not least because despite the boom in development of purpose-built stock, many universities’ old halls still need replacing. They are also under pressure to allocate capital reserves to the academic side, to remain competitive in attracting students. M&G and its peers are required to fill the accommodation funding gap.
McPhail adds: “For long-term pension fund money, it will invest in the sector so long as it can create sustainable income streams and I’m reasonably confident there is enough opportunity for that to continue for a while.”