In a way, the seeds planted by American Campus Communities (ACC) in 1994 blossomed late last year.
The Austin, Texas–based REIT did its first of 61 on-campus deals at Langston University in Oklahoma 18 years ago, when the concept of privatized student housing was still in its infancy.
Now, in the wake of the University of Kentucky’s deal to outsource its entire campus housing portfolio to Memphis, Tenn.–based REIT EdR, the privatization trend has matured, albeit in fits and starts.
Before Kentucky, there was Arizona State University (ASU) in Tempe. Since 2000, the school has developed approximately $700 million in new campus housing facilities with approximately 9,500 beds under privatized structures, with six providers. ACC, itself, is building 5,000 beds in five different projects and is also performing maintenance for 7,972 beds.
“ASU is the poster child of student housing privatization,” says Bill Bayless, CEO of ACC. “Kentucky is beginning a program, but you wouldn’t see a Kentucky without an ASU.”
Along the way, a who’s who of universities, like Princeton and Johns Hopkins, has dabbled in privatized on-campus housing. The University of California–Irvine, alone, has 4,000 privatized beds.
Student housing has long since shed its tag as a small niche and is now the darling of Wall Street and private equity. And with more students coming through college gates every year, coupled with ever-growing financial pressures on schools, there’s room for a lot more development.
The question is, who in the widely fragmented industry will be able to take advantage of this opportunity?
In the late ’90s, colleges and universities were keenly focused on limiting the risk that new housing projects had on their balance sheet. They established “related” real estate foundations and other entities in an effort to eliminate or minimize that peril.
That’s when the private sector stepped in. Birmingham, Ala.–based Capstone helped set up nonprofit, charitable 501(c)(3) foundations to own on-campus developments. It secured Moody’s Investors Service to rate bonds to finance the deals, and it pioneered the use of nonrecourse debt to fund on-campus projects. Before that, universities only used general obligation or auxiliary debt of the institution to fund these projects.
“I think our actions in the late 1990s started some movement toward greater university consideration of alternative means of development, management, and financing,” says Mike Mouron, Capstone’s CEO. “But many have contributed variations and enhancements along the way, and more will materialize in the years to come.”
Though Moody’s and Standard & Poor’s have begun to scrutinize how much these 501(c)(3)s really affect a university’s credit capacity, the trend toward privatization as a way to update aging housing stock continues. And that trend has particularly benefitted the big student housing players.
“You’re seeing flagship institutions saying, ‘We should be taking limited capital dollars and devoting them to our core academic mission,’?” Bayless says. “You’re seeing the outsourcing of the development of student housing.”
Despite that movement, no large school had decided to outsource everything until last winter.
“The University of Kentucky is the first major land grant institution that has said we’re going to revitalize our campus and will have a public company like EdR actually own and operate our housing,” says Tom Trubiana, chief investment officer of EdR.
The University of Kentucky Test
For several years, the University of Kentucky had been watching the student housing industry and trying to decide how to deal with its aging housing portfolio. When Dr. Eli Capilouto became president in July 2011, he made housing a top priority. After the board of trustees asked him to focus on student facilities in October, things moved quickly.
“It became a race to see how quickly we could transform the campus for our undergraduate students,” says Angie Martin, vice president of financial operations and the treasurer at the University of Kentucky. “Going through this, it became evident that if we could make a privatized housing arrangement work, that might be our best option.”
Martin says privatized housing appealed to Kentucky because it was “the best arrangement” for its students, but there were other major drivers as well. The Kentucky General Assembly has to authorize all projects and any debt the university wishes to issue. And it stipulates that all debt must amortize over 20 years.
“That will hinder our rate structures because we have to pay it off so quickly. How do you make a 20-year payback fit inside a rate schedule for a student?” Martin says. “It’s very difficult to do, especially with the magnitude of what we need to replace. We asked [ourselves] if we could get into a partnership arrangement [with a private student housing provider] where the return off their investment is structured over a longer period of time, therefore smoothing out the rate increases.”
After it glimpsed the possibilities, the University of Kentucky quickly came up with a way to preserve its credit capacity while adding sorely needed modern housing. In late 2011, it chose EdR to redevelop its housing in two phases and hold the properties under a 50-year ground lease.
In Phase I, EdR will develop, construct, and eventually own a 601-bed, $25.8 million freshman honors housing community under a long-term ground lease with the university. The university and EdR are talking about Phase II, which would include the systematic demolition of nearly all of the university’s current 6,000 on-campus beds and an expansion to 9,000 new residence hall beds in the next five to seven years.
If it works, Trubiana expects other schools to follow the model. “I don’t think this is a one-time situation,” he says. “It’s very important because of this magnitude. I know there are a lot of schools, and even systems, that are looking to Kentucky to see how this all works.”
In 2004, ACC became the first student housing firm to do an initial public offering (IPO). Though one of the major drivers was transparency, there were other benefits as well.
“Being public [for ACC and EdR] means much more financial transparency than their private-market counterparts,” says Andrew J. McCulloch, a managing director for Newport Beach, Calif.–based Green Street Advisors, who covers both ACC and EdR. “Universities find comfort in the fact that they can use public SEC filings to continuously monitor ACC’s and EdR’s financial health. Additionally, access to public equity gives ACC and EdR a distinct cost-of-capital advantage and access to liquidity at all points of the cycle.”
McCulloch is right. Martin confirmed that EdR’s transparency helped Kentucky make its choice. “Being public definitely helped, because we had to have someone who was transparent,” she says.
If the privatization at the University of Kentucky works, many people in the student housing business expect other schools to follow. If that happens, EdR and ACC could be fielding a lot of calls.
“There isn’t meaningful competition in terms of scale, financial wherewithal, and financial transparency that is so important to a university board,” says Paula Poskon, a senior research analyst with Milwaukee-based Robert W. Baird & Co. “It will be very hard for private companies to compete for the outsourcing of an entire university’s housing.”
Despite the appeal of the public markets for student operators, so far there haven’t been many IPOs. Charlotte, N.C.–based Campus Crest Communities went public last year after overcoming some initial hurdles. More IPOs could follow, but McCulloch warns that there will be issues.
“Potential IPO candidates need scale, an operating track record, an experienced management team, a sound corporate governance structure, a strong balance sheet, and a unique story,” McCulloch says. “Otherwise, IPO pricing would likely come in below NAV [net asset value].”
There’s speculation that demand for privatized on-campus housing could also draw seasoned multifamily operators into the space. Earlier this year, Arlington, Va.–based AvalonBay Communities told Multifamily Executive that it had looked into student housing in the past. But running market-rate and student platforms simultaneously is tough.
“You can’t lay student housing on a traditional multifamily platform,” says David Adelman, CEO of Philadelphia-based Campus Apartments (a company long rumored to be considering an IPO). “It doesn’t work that way. You have to be willing to have a siloed organization, which can be difficult.”
Not everyone is convinced the student sector can withstand a lot more competition. Undoubtedly, some of the new entrants chasing on-campus housing could end up off campus just because student housing is the hot ticket. Capstone’s Mouron, for one, fears that Wall Street and private equity attention in the wake of the University of Kentucky deal could ultimately hinder his sector.
“There’s not a week that goes by that we don’t get a call from somebody claiming to have access to an enormous amount of money, and I think some of them actually do,” Mouron says. “Student housing is still a small niche. I worry about the trouble caused by too much money chasing too few good deals.”