The cancellation of the NMHC Student Housing Conference — where many dealmaking meetings are held — took some wind out of the student housing investment sales market this fall. Activity was a little slower during the third quarter due to changes in the capital markets climate, but is expected to pick up as the year draws to a close and more sellers bring properties to market.
“August was a little bit slower, but now that we have the rent rolls for fall 2022 we are seeing a lot of assets hit the market,” says Teddy Leatherman, senior managing director, capital markets, with JLL. “Our team has never been busier from a broker’s opinion of value (BOV) or RFP standpoint.”
The investment sales market, overall, has had a strong year. Even removing Blackstone’s $13 billion acquisition of American Campus Communities from the market, the student housing sector has had a robust year. Add that transaction in the mix, and the industry will likely have a record year in 2022.
“The first three quarters of 2022 surpassed 2021’s volume and broke 2018’s record for annual transaction volume,” says Timothy Bradley, founder of TSB Capital Advisors and principal of TSB Realty. “With cap rates for Class A infill assets in top tier university markets dipping into the low 3 percentage zone early in the year and the completion of the largest transaction in industry history with Blackstone’s acquisition of ACC, the student sector continues to perform more steadily than many mainstream commercial real estate asset classes.”
While the investment sales was roaring in the first two quarters, the pace at which properties have come to market slowed dramatically during the third quarter.
“This is as slow a period as I’ve seen since 2009,” says Andrew Layton, chief acquisitions officer of Student Quarters. “The volume of product that has come into the marketplace is the lowest I’ve seen in many years. The quality of the product hasn’t changed.”
“Due to rising interest rates and volatility in the debt markets, it is increasingly challenging to peg pricing on assets, which is leading to slower transaction volume and a bid/ask spread between buyers and sellers,” says JD Goering, senior vice president of acquisitions at Landmark Properties.
Spring and summer saw fewer marketing launches because of the uncertainty of the debt markets, despite record fall lease-up numbers. Sellers have moved from a climate that had 4 percent cap rates and 65 percent loan-to-value ratios to one that has 50 to 60 percent loan-to-value rations, 6 percent interest rates and cap rates that reach above 5 percent.
“The volatility in the bond market has been the primary driver of the slowdown in transaction volume,” says Kevin Larimer, national director of student housing at Berkadia. “This is likely to continue until we see a stabilization in bond yields. It is extremely challenging to price assets when we are routinely seeing daily 8, 10 and sometimes even 20 or 25 basis point movements in interest rates.”
That volatility has created an issue for investors who have to place debt on their acquisitions, which happens to be most investors in the market. It has also created an issue for sellers, who have a problem accurately pricing an issue and figuring their returns.
“There is a massive disconnect due to the capital markets that is impacting sales volume,” says Layton. “If you were looking to take properties to the market and you ordered a BOV in the fourth quarter of 2021 or first quarter of 2022, you likely launched marketing at InterFace Student Housing in May. You may have launched, only to find that you launched in the beginning of a complete retrenchment of the debt markets. If you are a seller, your promised return and value expectations that were set in a markedly different environment than where we find ourselves today. There are many owners and sellers who are choosing to wait out this uncertainty.”
Because of the capital markets uncertainty many sellers have been reticent to bring properties to market, even if they are healthy and performing. There’s a feeling that buyers may perceive the property as distressed and must be sold, which could lead to low offers.
“If you are a seller, you really have to have a good strategic reason why now is the time for you to go to market because of the upheaval in the capital markets,” says Jaclyn Fitts, executive vice president and co-head of the national student housing team at CBRE.
“Properties need to either be in the very strongest markets, have a unique story allowing for major upside that can be easily unlocked, or be priced significantly lower than where assets were trading months ago,” says Isaac Sitt, co-CEO of Vesper Holdings, which is currently under contract on approximately $250 million worth of student housing acquisitions. “These properties are unique situations with massive management upside or a seller that was willing to sell for a heavily discounted price.”
Part of the lull has been due to the fact that many owners don’t want to sell; they are enjoying the strong performance of their properties.
“Due to the impressive operating fundamentals of student housing, many owners are focused on asset management and growing rents while working to control expenses, instead of contemplating selling assets in a volatile environment,” says Larimer.
That said, some market watchers say they still see owners bringing properties to market in the hope they will sell based on older market conditions.
“You still see a fair number of unrealistic sellers who are looking for a value that no longer exists and they are not prepared to take their medicine,” says Sean Lyons, founder and partner of Triad Real Estate Partners. “Deals with this profile simply are not trading right now. There are a smaller number of realistic sellers that need to transact for one reason or another — a partnership dispute, personal event, etc… — and they are willing to meet the current market. They are realistic about the fact that they have to accept lower pricing than they would have six months ago and that they have missed the window on selling at the top of the market.”
Turning on the Spigot
Many, including Student Quarters’ Layton, expect to see more properties enter the market during the fourth quarter, since there is still pent-up investor demand. And the industry had the largest first half of the year that the sector has ever had, according to Fitts and others.
“Overall, we are going to see a strong volume for the entire year but it will be weighted on the first half,” she says.
Investment sales executives say that a number of assets with loans maturing or those with pending refinancing are leading the charge of properties headed to market during the fourth quarter. With interest rates higher, many owners who have maturing loans that need to be refinanced are looking at the possibility of diminished returns in a time when they get can get a good price for their student housing property.
“In many situations, it makes more sense to sell,” says Leatherman.
One of the biggest reasons investment sales executives are seeing properties come to market is timing. Sellers who had lease-up issues during COVID who would have sold in fall 2020 or fall 2021 are now experiencing stronger fundamentals and can execute stalled exit plans.
“There are some sellers who were not able to transact because of COVID, but in the time since they have had amazing rent growth and strong occupancy for 2022-2023, so they have realized it’s time for them to go to market,” says Fitts.
Despite current slow volume, investment sales executives say that fundamentals in the industry make the timing right for some industry players to buy.
“In terms of performance metrics like occupancy, rent growth and leasing velocity, for student housing is better than ever,” says Douglas Sitt, co-head of student housing at Rittenhouse Realty. “The sector has still continued to perform extremely well, despite the capital markets.”
“Outsized rent growth and limited new construction has created a scarcity premium that continues to drive pricing and interest in major markets throughout the country,” says Ryan Lang, vice chairman of multifamily capital markets at Newmark.
Many properties that Leatherman and her team brought to market in April are starting to close at the end of the third quarter. Fall 2022 saw record pre-leasing numbers in most markets. Coupled with the rise in interest rates, there was a rush to market during the second quarter.
“We really encouraged our clients to launch as soon as possible this year,” says Leatherman. “Many sellers this year felt like they left a lot of room for further rent growth in fall 2022. New owners are really looking to push rents in fall 2023. Next year you are going to see some outsized rent growth.”
Fitts and her team at CBRE have launched a number of assets into the market this fall, including a value-add portfolio and a number of single asset offerings.
“From a buyer’s perspective, it is a very hard environment to get deals done,” says Layton. “We closed six deals in the first half of the year because we had them locked from the debt side. It is a far more challenging environment than it was in the first two quarters.”
Buyers today have to factor in more expensive debt to their return profiles, meaning they are scrutinizing proformas on any acquisitions. Sellers, also, have been refiguring their projected returns.
“They are reconsidering what their residual cap rates look like in their IRR calculations,” says Fitts. “We have seen a lot of buyers revising that number, which impacts the overall pricing.”
While many core funds and institutional investors appear to be waiting on the sidelines, owner-operators with turnaround experience, or experience in creating value from already strong properties, are forging ahead with acquisitions.
“For stabilized properties that are already exhibiting strong rent growth in strong markets, the sky seems to be the limit on buyer interest,” says Troy Manson, chief investment officer of University Partners. “That may only be tempered by some uncertainty in the capital markets given recent inflation news. Debt is still a limiting factor, but outsized rent growth can help salve the pain of negative going-in leverage.”
Once they enter escrow, student housing properties are taking longer to close. Most of that is due to lenders hesitancy to give quotes and the difficulty buyers are having in finding financing.
The strong fundamentals of the student housing market continue to attract many investor groups, even with market volatility. A number of buyers are not daunted by market conditions. Some are seeking the deals that must sell due to impending refinancing, or are otherwise showing some sign of duress.
“There are plenty of groups that understand there is a tremendous opportunity to make concerted bets through the capital markets’ choppiness, particularly with several large institutional players currently on the quieter side,” says Lang. “While overall deal volume will likely be down from historic highs, we expect sustained demand into the fall as the market settles into the current landscape.”
Buyers who are active in the market have to be prepared for changing market conditions, and have to be ready to deploy their capital.
“The most successful buyers are the ones with the funds already raised and strong relationships with lenders,” says Bradley. “We are surprised by some of the lenders pretty much closing for the second half of the year unless there was a strong pre-existing relationship. We’re encouraged by the continued presence of new groups, both domestic and international, looking to enter the student housing sector, especially with how the space had shown to be recession resisilient.”
Some properties are transacting as loan assumptions — where the buyer assumes the existing financing on the property — to avoid the capital markets. Rittenhouse Realty has five deals under contract that are loan assumptions.
“The leverage is key in those deals. The buyers will likely have to put more equity in to assume the loan,” says Ken Wellar, managing partner at Rittenhouse Realty. “Since these loans have been in place for a few years, the equity requirement is going to be higher than it would be if it were new financing, but the interest rates of the loans are much better.”
Lyons is also seeing buyers particularly interested in this type of transaction.
“There are plenty of buyers in the market for loan assumption deals, assuming that the leverage is reasonable,” he says. “The properties that were refinanced most recently would have the best chance to trade as their assumable loan will be much lower than where the market is today.”
Other investors are looking for opportunity.
“There has been a pivot to more value-add and opportunistic yields as investors look for different avenues to place capital while weathering the temporary macro uncertainty,” says Lang.
“Although the fundamentals of our space are better than ever, the macroeconomic environment is a major drag on activity,” adds Isaac Sitt. “Debt costs have skyrocketed with no end in sight and there is a major concern about a looming recession. This has created uncertainty in the market and sidelined some of the major capital players. We see this as a huge opportunity. We believe that student housing will sustain strong rent growth and occupancy that more than makes up for any increased debt costs. We are actively buying, but are extremely selective as to which markets we will buy in and are conservative as to where cap rates will be when we expect to exit.”
What comes next?
Market players think the first thing ahead is going to be pent-up demand from buyers. While there are properties coming to market, many institutional buyers have been on the sidelines. Once they adjust to the reality of new market conditions, they will re-enter the market.
“We are in a unique time where interest rates have increased rapidly in a short period of time, causing a slowdown in transaction volume,” says Goering. “I see buyers being patient and waiting for the market to correct versus turning away from student housing and looking at other asset classes.”
“Our team sees pent-up demand driving activity in 2023, particularly among investment funds, as groups find themselves under-allocated and seeking to expedite capital outflow,” adds Lang.
Sellers are expected to warm to the market as well, especially with property operations fundamentals continuing to be strong.
“I have spoken to multiple sellers in the past few months who said they are waiting for the dust to settle on 2022 and will potentially look at bringing their property to market in 2023 once the market has had more time to adapt to current realities,” says Lyons.
Property values should increase with the forces present in the market, putting more pressure on owners to extract value.
“There is a projected record-breaking pre-leasing velocity already for the 2023-2024 academic year and fewer new project deliveries projected for 2023, 2024 and 2025 due to the continued increased costs for development and financing,” says Bradley. “We feel the tailwinds for student housing for the next lease-up cycle and project a similar story for 2024-2025.”
Big picture, many in the student housing sector see the clouds clearing as sellers adjust to new market conditions.
“The market will correct itself with time, as it always does,” says Lyons. “Once it becomes undeniably clear to all parties involved that higher interest rates are here to stay, we will likely begin to see transaction volume pick back up in 2023 and beyond at the newly adjusted values. The overall interest in investing in the space has not been significantly impacted at all, which I see as a very positive sign going forward.”
This article was originally published in the September/October issue of Student Housing Business magazine.