Luxury student housing properties, complete with rooftop swimming pools and opulent lobbies, have been a hallmark of the current development cycle.
Indeed, with capital flooding the sector, the post-Great Recession student housing boom has been held up as the category's coming-of-age party, when it shed its mom-and-pop image to emerge as a true institutional asset class. As some evidence of that, student housing property prices hit an all-time high this summer.
But now, the converging trends of increased supply and declining enrollment at institutions across the country, paired with rising defaults on student housing-related commercial mortgage-backed securities (CMBS), are casting a shadow on the asset class.
Student housing accounts for 40% of defaults in the multifamily sector, despite representing less than 6% of loans, according to Moody's. Viewed in light of a particularly acrimonious dispute at the University of Oklahoma over a public-private partnership (P3) — another hallmark of this cycle — it raises the question of whether student housing's party, which has carried on for the better part of 10 years, is now stumbling toward the exits.
"Following a decade where everybody was anxious to build, build, build — and not just dorms — this glut of real estate is going to have to be dealt with going forward," said Jean Close, an accountant and partner at The Bonadio Group, which performs audits for higher education institutions. "Is it going to be a problem? Absolutely. And it's a little frightening."
Enrollments are declining and that trend is expected to continue, with one forecast anticipating a 15% drop in the college-age student population between 2025 and 2029. That's at least partly an outcome of the last recession, as families tend to put off having children during lean times.
"We're in a dip now, 18 years after (the recession of) 2001, and another big dip is on its way in 2025, 18 years after the financial crisis that started in 2007," said Doug Shapiro, executive research director of the National Student Clearinghouse Research Center, which tracks enrollment nationally. "So a lot of colleges and universities are looking at those trends and really starting to worry about where their new students are going to come from over the next decade."
Observers note that each institution and student housing market will experience the decline differently, with larger and more selective universities still faring relatively well. Smaller and regional colleges, which have been struggling, will likely feel the brunt of the drop off. Projects in tight housing markets such as Boston should have continued demand, while those in less-constrained markets, including the Midwest, could see oversupply.
Two types of development factor in: private apartments built by student housing developers off campus and P3s in which private developers partner with universities to build student housing, usually on campus.
The two are related, with the luxury amenities that originated in off-campus housing pushing universities into their own amenities arms races on campus. In turn, the luxury, apartment-like campus dorms are being used to entice the shrinking pool of applicants to attend one institution over another.
Off-campus deals abound
Investors have been pouring into the private, off-campus housing sector since 2009. In that time, deal volumes rose from $1 billion or $2 billion annually to nearly $10 billion by 2018, with prices reaching their highest point ever this summer, according to Jim Costello, senior vice president at real estate deal tracking firm Real Capital Analytics.
In the last five years, that has translated into developers adding between 43,000 and 47,000 beds annually, per multifamily software and data provider RealPage's third-quarter 2019 student housing market update.
But this year, as occupancies at off-campus, purpose-built student housing projects stayed flat from 2018 — for about half the schools RealPage tracks, those are at 92% occupancy or less — the number of defaults in the space has increased. Nearly 3% of student housing CMBS loans are in default, compared to just 0.4% for the multifamily sector in general, said Kevin Fagan, a senior analyst at Moody's.
"We highlighted 17 student housing defaults on loans that had originated over the last 10 years," Fagan said. "Of those, 12 were at schools with declining enrollment."
And the other five? "Even if enrollment is going up, you're not guaranteed to have positive performance at your property," he said. A growing student body attracts development, which heightens competition to fill a greater supply of beds, both on and off campus.
A 'moral obligation'?
Against that backdrop, a major P3 at the University of Oklahoma that was struggling to fill its beds blew up in investors faces' recently, when, according to Bloomberg, the institution decided not to renew leases on commercial and parking space at Cross Village, a $250 million, 1,230-bed project developed on its campus by Baton Rouge, Louisiana-based Provident Resources Group.
P3s have become an increasingly popular development vehicle in higher ed. They take both financial and operational risk off of universities while allowing for the development of more luxury beds on campus. That's a potential selling point for institutions amid a shrinking applicant pool.
While each deal is unique, the general structure involves a university leasing its land to a private developer, which trades on the university's name to raise debt or equity to build, own and operate the housing. The developer, not the university, is on the hook for the financing, and it pockets any profits from the operation of the building before making lease payments back to the university.
"That's where the university has skin in the game," said Gauri Gupta, a credit analyst at S&P Global Ratings. "If the developer isn't making a profit, the university is not getting paid on the ground lease."
At the end of the lease term, typically several decades later, ownership of the building reverts to the institution.
There's a catch, though. Bonds can't be sold by a public entity without voter approval, so P3s are financed with either debt or equity investments that the developer raises in the marketplace based on the fact that they have a deal with the university. That means the partnerships are based on a "moral obligation," and not a legal one, from the university to operate in good faith on the agreement. That issue was cited in the debacle at U of Oklahoma. From that perspective, the deals contain more reputational than financial risk for universities.
At Cross Village, where occupancy hadn't topped 35% in the year since opening, the university was paying Provident roughly $7 million a year but claimed only to be generating $40,000, the Tulsa World reported. With more than $900 million in debt on its books already, the university effectively walked, claiming it wasn't legally obligated to renew the leases.
Provident CEO Steve Hicks warned of the situation's potential effect on the broader market. "I will need to think long and hard before exploring any other P3 project that shares comparable characteristics," Hicks wrote in an editorial in The Bond Buyer last month. "My fear is that this situation will become a template for other creditworthy public partners that simply change their minds about deals and abandon their partners when convenient."
Indeed, in the public sector, many large infrastructure contracting firms have begun to eschew P3s, saying they put too much risk on contractors, while the Trump administration, which once endorsed P3s, has cooled toward them.
Still, analysts say the Oklahoma situation is an outlier, and that colleges will continue to look to the private sector for investment in student housing.
"Institutions might have to come up with more creative ways to market them, and the partnerships might need to get stronger so we don't see Oklahoma-type deals repeat, but I don't think this is going to stop anytime soon," said S&P's Gupta. She notes that her universe of P3 coverage has added 11 deals in the last year.
Were the wheels to come completely off a P3 deal, and a building funded by private investors was foreclosed upon on university land, the outcome could be murky.
"We don't really have a lot of precedent to look at," said Jessica Wood, senior director and education sector lead at S&P. "Bondholders would likely have the right to vote on the outcome, and the institution would most likely have the right of first refusal."
'How do you retool that?'
Even as colleges pack their campuses with amenities and remain a magnet for private developers to do similarly nearby, Costello expects any fallout wouldn't occur across the board. "There will be selection bias," he said, with elite institutions continuing to attract students.
He notes, too, that the use of debt in financing real estate deals isn't as high now as it was before the 2008 financial crisis. And even though student housing accounts for 40% of all multifamily defaults, the dollar amount is a relatively small part of the overall debt market, he said.
Moody's Fagan agrees, pointing to the structure of today's deals. "There's no massive issuance of bonds, and then derivatives off of those bonds, as happened in the last crash," he said.
"Following a decade where everybody was anxious to build, build, build — and not just dorms — this glut of real estate is going to have to be dealt with going forward."
Accountant and partner, The Bonadio Group
Of course, few observers anticipated defaults on single-family home loans leading up to the financial meltdown of 2008. And the history of past crashes is littered with utterances of, "It's different this time."
That's partly why other observers see a reason for caution. "There is obviously going to be excess capacity on many campuses," Close said. "The question becomes, how do you retool that? What do you do with it?"
One answer may be selling excess property or partnering with other organizations to put additional capacity to use. She points to Colgate Rochester Crozer Divinity School, in Rochester, New York, which recently sold its 22-acre campus to a private developer when enrollment dropped to around 100 students.
Earlier, it partnered with the American Cancer Society to use excess space for temporary housing.
More affiliations between colleges are also expected, Close said.
The trend could go the other way, too, with private developers looking to be bailed out by the universities they've built their projects near.
"The dream of many developers is that the university will sweep in and rescue it, and then it'll be the taxpayers' problem to solve," said Stephen Harrison, vice president for auxiliary enterprises at Coastal Carolina University, in South Carolina.
"That's not something that campuses are likely to do," he continued, "although we may be asked if there are other functions for a building that's essentially adjacent to our campus, such as for offices or classrooms."