Illiquidity In Retail Student Accommodation Investment Would Be Addressed By a Specialist REIT
Student Lets – Sound But Illiquid Investment
Some months back, we at invezz.com wrote a piece (it’s here) on student accommodation investment, then – and still – being hyped as providing the best returns to be had in UK real estate. For the mainstream private investor though, the option was and is largely confined the purchase of a discrete room – a ‘pod’ – in either a purpose-built or refurbished student hall of residence. Any other investment in student accommodation is just a standard real estate investment in an apartment that happens to be in proximity to a university and likely to attract student tenants.
This product is typically marketed by investment-oriented agencies of diverse size and renown and there’s a certain sameness to the deals on offer: affordable pricing, between £30,000 and £40,000 being typical, low down-payment, instalments spread over the life of the build or refurbishment project, a ‘guaranteed’ rate of return – between eight and 10 percent – over a given period (such as five years), and invariably an ‘exit mechanism’ or ‘strategy’.
Assuming the rest of the deal is all good – a real developer doing a real development – it’s this last item which caused us to close our earlier piece with a note of caution about student ‘pod’ investments. Fact is, there is no open, transparent – or indeed any – secondary market for such investments and, for an initial buyer needing to liquidate the investment down the track, the ‘exit mechanism’ offered in the purchase paperwork may well be the only way out. But in one promotion which just landed in our inbox – for 20 pods in what appears to be a church conversion in Nottingham – it’s apparent that the ‘exit strategy’ resides in an option reserved to the developer to buy back the interest after five years, at 110 percent of the purchase price. Note that word ‘option’ – in its ordinary meaning conferring a discretion whether to buy or not – which is hardly a guaranteed exit mechanism for the investor. One would definitely want to focus on the fine print before committing to a purchase.
So the lack of liquidity is a definite drawback for ‘Joe Public’ investment in student accommodation. Which is a shame because in all other respects, the sector seems to justify the hype – notably, that it’s been outperforming the rest of the UK property market since onset of the financial crisis in 2008.
Preserve of the Wealthy
Proof of that particular pudding lies in even a casual glance at who is buying into student accommodation. The short answer is, private wealth – and a lot of it isn’t British. From a standing start a few short years ago, the UK’s student accommodation market was recently calculated by realtor CBRE as having generated £2.7 billion in transactions in 2012. And their August 2012 edition of ‘Student Housing Viewpoint’ contains some interesting insights into a world which, by and large, bypasses the ordinary investor. Indeed, with the exception of the largest operator – Unite Group plc (LON: UTG), with some 42,000 beds under management – none of the top five operators, accounting for nearly two-thirds of the 180,000 student beds in the private sector, are listed or otherwise in obviously British public ownership.
Thus, for example, late last year a Barclays client investment fund sold a 60 percent stake in the second-largest operator, UPP (28,000 beds), to Dutch pension fund administrator PGGM, reportedly for £840 million. And as I write, at the end of January, Bloomberg is reporting the bank’s divestment of its remaining 40 percent – to Gingko Tree Investment, a Chinese state-backed investment fund.
Of the next three in the CBRE pecking order, Opal (20,000 beds) and CRM (11,000) are privately-owned entities. Separating them is Liberty Living, with 16,000 beds under management. This is the management arm of the Brandeaux Student Accommodation Fund, which is something of a hybrid. It’s unlisted but has tradable securities on issue, with a registry maintained in the British Virgin Islands.
That major Dutch investment aside, there’s growing American money in the UK’s student accommodation investment market. Case in point – partially-listed venture capitalist Oaktree Capital Management LLC (NYSE: OAK), with over $75 billion in assets world-wide and still controlled by its founding partners, recently entered via a wholly-owned subsidiary, Knightsbridge Student Housing Ltd. Its ‘Student Housing Company’ brand has been tacked to nearly 1,700 bed-heads in London and the south of England, with a further 2,900 in the pipeline. And there’s Middle Eastern, Shari’ah-compliant investment – such as the AUB UK Student Accommodation Fund, which hails out of the Ahli United Bank of Bahrain. In 2011, the fund made an inaugural foray into the sector via Sidney Webb House, a seven-storey, 446-bed student residence in central London, snapped up for £23.3 million, and a smaller property in Leeds for around £15 million.
And even when the money is British, for the most part it’s only the wealthy few who can buy directly into significant chunks of the UK’s student accommodation stock via investment funds, since most are closed – the stakes aren’t traded on any public market or otherwise freely transferable – and anyway require investment of an order beyond what most of us could ever contemplate. The Brandeaux fund mentioned earlier is an exception, in that individual units can theoretically be bought by all and sundry, though only through investment advisers. Also, the investment is offshore and the market is unregulated.
Student Accommodation Investment – A Retail Investor Wish-list
What, it seems to us, is needed in relation to student housing is a vehicle for investment in this attractive part of the UK’s real estate sector which (a) allows direct exposure to the sector, (b) is affordable for mainstream investors, (c) is liquid – there’s an active secondary market, and (d) is regulated like other listed securities, thus instilling a high level of investor confidence, which in turn aids liquidity.
Enter the REIT
The obvious answer would seem to be a REIT – a real estate investment trust . Despite the use of the word ‘trust’, a REIT is a company like other listed entities, in that it issues shares. But the key to REIT status is that, for tax purposes, the company is a ‘pass through’ entity. A REIT’s income from rents – which must be at least 75 percent of total income – is not taxed in its hands. Tax is paid only by its upstream investors, at their individual tax rates.
The nearest thing to a Real Estate Investment Trust currently in the student accommodation scene is the aforementioned Unite Group plc. Indeed, in a piece last April, which colourfully describes Unite as “a ‘Marmite’ stock – you either love it or hate it”, the Financial Times’ David Stevenson asserted that the company is a Real Estate Investment Trust. But it isn’t – it’s not registered as such and doesn’t itself claim such status. Currently there are no UK-REITs focused on housing of any ilk, with just three of the 20-odd listed REITs having modest residential holdings.
Super-sized US Student Let REITs
In the United States, by contrast, student housing is an established part of the listed REIT scene. The largest example is Texas-based American Campus Communities, Inc (NYSE: ACC), which owns 160 properties across the US and in Canada, comprising nearly 100,000 beds, with another 30,000 under management, and a market capitalisation just shy of $5 billion. Unite, the biggest by far UK player and valued by the market at £460 million, is a relative minnow.
Of course, unlike in the States where they’ve been around for over 50 years, real estate investment trusts are in their infancy in the UK – from the beginning of 2007, under enabling legislation enacted the previous year and just in time to be crunched, along with the rest of the UK’s property market, by the global credit crisis. It’s to the credit of the Real Estate Investment Trust structure that all bar one of these enterprises have survived the storm (the exception being Warner Estate Holdings plc (LON: WNER), now in receivership).
So why isn’t Unite Group plc a REIT? In a statement to the markets back in 2006, the company advised that it had given detailed consideration to the notion but, ‘[w]e have concluded that UNITE is unlikely to convert to REIT status in the short term, given our continuing levels of development activity.’ Income from property development, or dealing for that matter, doesn’t enjoy tax-free status and, according to the FT piece mentioned earlier, some 30 percent of Unite’s income is development-related.
Growing Interest in UK?
We nevertheless think it highly likely that some existing players in the student accommodation investment market are actively considering the use of REIT status. And CBRE, in their student housing market overview last August, also raised the idea, in a section headed ‘Indirect Investment – Changes to REITs an Opportunity?’ Investment via a Real Estate Investment Trust is only ‘indirect’ in the sense that the investment vehicle holds legal title to the rental properties – and of course provides for a fee their management on behalf of investors. From an income perspective, a stake in a REIT is ‘direct’ – by law, a minimum of 90 percent of rental receipts minus operating costs must be distributed to investors each year, with the REIT being an untaxed conduit.
Other Options – For Now
As the CBRE overview noted, the relaxed rules for REIT status introduced last July have increased the likelihood of new real estate investment trusts coming to market. These could be either existing property companies or start-up operations. A primary reason why either would go the REIT route would be to attract investment finance not otherwise available, or at least not on attractive terms, from traditional sources such as banks. And perhaps, with student accommodation, it’s this factor which explains the sector’s absence from the REIT scene. Because student housing is proving so rewarding investment-wise, the sector is attracting big ‘wholesale’ money via institutions and wealth funds and, to this point at least, hasn’t needed to go to the retail market.
Or it’s doing so in different ways. Back to Unite – on 21 November last year it launched an eight-year retail bond paying a whopping 6.125 percent, available on £2,000 down and then in multiples of £100. The company announced closure of the issue on 3 December, two days ahead of schedule and with a tidy £75 million in the kitty.
Change in the Wind?
The disinterest in ‘retail’ equity participation might be about to change though, with the driver coming from the universities and other tertiary institutes which still own the bulk – over 70 percent – of the UK’s student housing. Much of which is in need of overhaul in the short to medium term, if the expectations of both domestic and international students now paying £9,000 and more per year in student fees are to be accommodated. Grot no longer does, if it ever did.In its own take on student accommodation investment last year (‘Spotlight Student Housing – Summer 2012’), realtor Savills UK seizes on this point to suggest that the growing need for upgrade of category C and D student halls (sub-standard and beyond, according to Higher Education Funding Council ratings) to category B or better could stimulate a fresh wave of private sector investment in student housing. The tertiary institutes – suffering a contraction of endowment and other traditional funding – will put greater focus on ways and means of avoiding costly repair bills and generating fresh capital. Some, suggest Savills, will get into bed with private wealth. But for others, a tie-up with a purpose-built Real Estate Investment Trust may prove to be an appealing alternative, perhaps with a core placement directed to local residents, supporters and alumni.
Good Show, Old Boy!
Government blessing could reasonably be expected for such initiatives. The current administration has identified REIT growth as a way of stimulating fresh investment in Britain’s moribund housing market, has moved to make it easier for existing and start-up enterprises to go the REIT route, and – while student housing is outside the mainstream – has signalled its in-principle wish for ordinary Brits to have the opportunity to invest in the housing market. Further tinkering with the REIT regime can’t be discounted but it’s tolerably clear from a review concluded in December in relation to social housing that the government sees the existing rules – especially as regards REIT tax-exempt status – as appropriate going forward.
Message being – hopefully – that prospective entrants into the REIT scene, be they Russell Group universities looking for cash or Wall Street hedge funds looking for new angles, can plan in relative confidence.
Watch this space.