As students continue to arrive on college campuses across the country every fall, developers have continued building apartment complexes to keep up with demand for student housing, resulting in a large spike in off-campus construction in the last several years. According to a March 2015 article in the National Real Estate Investor, developers added approximately 60,000 and 63,000 beds to the student housing inventory in 2013 and 2014, respectively. While construction ahead of the 2015-2016 school year is expected to be lower at just 48,000, this still exceeds inventory growth for this property type at the peak of the market in 2008. The CMBS industry has also seen an uptick in the number of student housing properties being securitized in transactions. Based on a study of loan data conducted by DBRS, the increase of these securitizations seems to mimic the frequency of watchlist, delinquency and special servicing events associated with student housing properties across CMBS transactions issued in 2010 and later. This would lead one to believe that loans secured by student housing properties are more prone to default than those secured by traditional multifamily properties.
As a sub-category of multifamily properties, student housing assets have been deemed by DBRS to carry a greater probability of default given their vulnerability to shifts in occupancy and cash flow. All leases generally start and expire in the same month, depending on whether nine-month or 12- month leases are required. If an operator misses during the critical, concentrated leasing period for college students who need to secure housing ahead of the fall semester, it becomes challenging to make up the lost ground during the school year and maintain market rental rates. In comparison, traditional multifamily properties benefit from a more diverse tenant profile with lease expiration dates that are spread more evenly throughout the year. The result is two-fold: greater occupancy volatility and greater cash flow volatility for student housing properties compared to non-student housing properties.
The graph below compares the volatility1 of occupancy and net cash flow between student housing and non-student housing properties securitized in CMBS transactions since 2010. The year-over-year occupancy and net cash flow changes were calculated using the FYE financials as reported in the investor reporting package (IRP) for each financial year reported.
Perhaps the most significant performance factor for any student housing venture is its proximity to a college campus. This geographic limitation means that developers have had to find other ways to market a property’s appeal. Many in the industry have commented on the growing list of demands student tenants bring to the table. These include tenant lounges, resort-style pools, game rooms, fitness centers, tanning beds, campus shuttles and high end finishes such as granite counter tops, stainless steel appliances and upgraded flooring. It is not uncommon for property managers to offer leasing incentives such as gift cards or flat-screen televisions, and many, if not all, of these amenities are deemed necessary to remain competitive as new student housing properties are added to the market. It would follow, then, that replacement costs and operating expenditures for these properties are higher than those that do not cater to students.
DBRS sampled all multifamily properties securitized in CMBS deals of all vintages and based on borrower reported financials (rather than servicer normalized), found that the expense ratio between student housing (44.2%) and non-student housing properties (45.2%) are essentially the same. The data does suggest, however, that reported replacement costs were are on average 20.6% higher for student housing properties ($268.25 per unit) than non-student housing properties ($222.47 per unit). While there are some in the market, including DBRS, which underwrite above-average capital expenditures on properties with student concentrations in order to reflect this trend, it is not a method employed universally among lenders.
In legacy CMBS (transactions issued prior to 2010) student housing properties have roughly the same probability of loss (10.3%) when compared to non-student housing multifamily properties (11.1%); they have a similar albeit slightly higher loss severity (53% vs. 49%) . However, there is reason to suspect that CMBS 2,0 student housing is different than the legacy student housing and that its performance will be different than non-student housing multifamily going forward. As noted in the graph below, the watchlist rate for student housing properties securitized in transactions issued in 2010 through present day is significantly higher than the watchlist rate for non-student housing multifamily properties.
Breaking out those transactions issued by Freddie Mac, the trend continues, which is interesting given the agency’s well-defined lending guidelines. In the CMBS industry, it is widely believed that Freddie Mac (and its GSE sister, Fannie Mae) is offered the first look to lend on multifamily properties because of its attractive cost of capital and therefore can be selective in its lending practices. The elevated watchlist rate of even Freddie Mac loans secured by student housing properties versus non-student housing multifamily Freddie Mac loans further perpetuates the perception of increased volatility associated with these assets.
One can argue that there are non-performance related reasons a loan may be flagged by the servicer for watchlist status, including borrower issues and upcoming maturity. Upon further analysis, DBRS has concluded that most of the loans included in the count above are currently on the watchlist for performance-related issues. CREFC guidelines dictate that properties experiencing a substantial decline in occupancy may be flagged for the watchlist, though the investor reporting package does not account for seasonality. Given the nature of student housing, it is common that these asset types experience higher vacancy during the summer months. Freddie Mac generally requires that its borrowers submit financial reports on a quarterly basis, which would theoretically lead to a rise of loans secured by student housing properties flagged for occupancy issues in those quarterly reporting periods that fall during the summer months. Based on its review of the data, DBRS does not believe seasonality to be a driving factor behind the propensity of student housing properties to fall on the servicer’s watchlist. Beyond the watchlist, loans secured by student housing properties also experience delinquency and special servicing transfers more often than loans secured by traditional multifamily properties, as illustrated in the charts below.
As long as university enrollment continues to increase and on-campus development remains stagnant, developers of off-campus student housing will continue to see business opportunities. It would stand to reason that the largest and most popular universities will support a more sustainable student housing market. This opinion is echoed by senior industry professionals, who regularly prefer large schools in states such as Texas, Florida and Virginia, where student enrollments and demand for housing continues to rise. The expectation for new construction and increased competition means that owners will need to constantly invest in their properties to remain viable in the student housing sector with the added challenge of convincing tenants and their cosigners that the upgrades are worth the rising rental rates. DBRS does not expect to see a slow-down in the securitization of student housing collateral in the near term, but will continue to view this particular property type as being susceptible to higher credit risk than traditional multifamily. Since demand is directly correlated with college enrollment, greater volatility in occupancy rates and net cash flow and historic performance issues is to be expected.