Student Sector Can Prove Its Countercyclical Chops During Current Turmoil
The UK student accommodation sector's credentials as a countercyclical market that can continue to perform well as other areas of commercial real estate struggle will be put to the test in coming months.
On one hand: the continuing expectation of strong demand from students for UK higher education and the structural undersupply of both purpose-built student accommodation and housing of all kinds in big UK towns and cities.
On the other: financial market turmoil that no area of real estate can escape and the particular vulnerability of the student accommodation business model to the sharp rise in energy prices.
“There have been more black swans than white swans in the 20 years I’ve been investing in this sector,” Round Hill Capital Head of Student Brian Welsh told the audience at Bisnow London’s Student Housing Roundup, held at the Royal Society of Chemistry in London. “In all those years, growth has kept going on regardless.”
Welsh pointed to 2012 as a year that was supposed to be cataclysmic for UK student housing real estate: new, higher tuition fees were introduced, and a huge glut of new supply hit the sector. But occupancy at Unite, the listed student housing giant seen as a proxy for the sector, remained at 95%.
Dominvs Group Chief Financial Officer Ian Trinder explained why the company had diversified from a hotel specialist into developing new student accommodation schemes on prime London sites.
“We saw an arbitrage between hotel yields at 6-7% and student housing yields at 3-4%,” Trinder said. “We are attracted by the stable income and the fact that the sector trades well during a recession. During the worst of the pandemic, occupancy in good student schemes dropped to about 75%. Occupancy in hotels dropped to zero.”
But the talk about yields highlights the fact that in spite of its operational resilience down the years, like all sectors of property, the investment horizon looks a lot less rosy.
The discussion took place during a week in which financial markets priced in interest rates rising to as high as 6% to counteract the falling value of the pound. That affects the metrics for anyone looking to invest in any sector of real estate, because when interest rates rise, property values generally have to fall.
“We’re pricing transactions, and what our model is showing this week is completely different to two weeks ago,” Patron Capital partner Irina Stamate-Rocha said. “It's not just that borrowing costs have changed, you have to think through your exit yields as well — will they move up as rates move up?”
A total of £4.4B was invested in UK student accommodation in 2021, down from £5.2B in 2019, according to data from Knight Frank. CBRE predicted £6B would be spent in the sector this year, although that prediction came before this month’s stark rise in expected interest rates.
Trinder said that Dominvs had been in talks with potential forward funding partners for schemes in its development pipeline in London, following on from its recent deal with Scape to forward fund a £173M scheme in Hammersmith, the UK’s largest ever student forward funding deal.
But these deals are essentially on hiatus while everybody works out what higher interest rates mean for pricing.
Aldermore Commercial Director John Carter said the lender was still open for new business, and that he had seen two or three deals come across its desk in the past week that other lenders passed on because they couldn’t price during the current volatility.
Another banker, however, warned there is a mismatch between yields, particularly in the London market, and the new cost of debt.
“How does it work when yields are below 4%, but the cost of the debt I can offer is twice that,” Allied Irish Bank GB Corporate Relationship Manager Kieran Redford asked. “It’s going to be an interesting 12 months for the London market.”
Another issue for the sector outlined at the event was the rise in energy costs being experienced in the UK.
Because student accommodation typically offers an all-inclusive package that rolls rent and bills into one flat fee for students, it is more difficult for operators to pass on rises to their customers.
The government has said it will cap price rises for businesses in the six months from October, but has not yet given details of how that cap will work in practice.
“A lot of operators hedge their energy costs, but as those deals come off, we’re in for some turmoil in the sector,” Hines Managing Director of Aparto and Operations Tom Rix said.
He added the price rises were an impetus for operators to change the behaviour of students, making them aware of how much energy they are consuming as a first step toward helping them reduce usage.
Student Hotel Head of UK Development Ilya Tabachinskiy gave a neat example of how this can work in practice. In the showers at its operational schemes, there is a picture of a polar bear. The longer someone stays in the shower, the more the ice on which the bear sits melts. Stay in the shower too long and the polar bear drowns. Since introducing the prompt, water usage at its schemes has reduced 20%.
When it comes to energy prices, Patron’s Stamate-Rocha had words of reassurance.
“Student accommodation should be able to increase rents to a level to make up for this rising cost because the demand is so high,” she said. “Students need this accommodation and in good areas, there’s shortage.”