Student housing has changed from a fringe investment to a global market worth today circa $200bn. This has been underpinned by a doubling of the number of students worldwide over the last decade. Institutional investors have been attracted to this asset class due to the relatively high returns on offer, combined with security of demand and covenant. The market is, however, still undersupplied in many university cities within the UK. Capital is available from pension funds who seek secure cashflow with a long term link to inflation.
Student accommodation projects may be commercially-procured, or they may be procured by the university itself.
Commercially-procured student housing developments generally fall into two categories:
- Commercial developments near university campuses where the university simply agrees to allow the developers to promote the project on-site and to seek students.
- Commercial developments where the university enters into a nomination agreement, whereby it agrees to nominate a minimum number of students into the accommodation each year and for an agreed period in return for more control on rents and operational matters.
Harper Macleod has acted for numerous developers of commercially-procured student housing projects, including acting for Derwent Housing Association in its capacity as investor, developer and facilities management provider in a number of such projects.
Another type of student accommodation project is university-procured projects on campus where the university has varying degrees of control, but often to get that control, the university has to make a commitment through a nomination agreement.
Projects procured by a university will usually be structured on a design, build, finance and maintain basis. The selected private sector partner brings together a consortium of a builder (to construct the accommodation), an operator (to maintain the facilities) and a financing lender/institution (to fund the build costs).
Harper Macleod acted in 2014 for the University of St Andrews on the redevelopment of a large student residence at FifePark. The development is being constructed and managed in partnership with Campus Living Villages. M&G Investments have provided project finance under a bespoke leasing and governance structure with rent reviews linked to inflation and management controls retained by the University.
Harper Macleod also acted for Derwent Housing Association in a £180m bond-financed university-procured student accommodation project for the University of Hertfordshire.
Of course, student accommodation development is about more than just bricks and mortar - student accommodation needs maintenance staff, cleaning staff etc. A variety of models for delivery of such services are available, ranging from full delivery by the private sector of all services, to more limited models where the university retains responsibility for facilities management of these services.
Key issues related to service delivery are:
- Staff are more likely to be transferred to the private sector partner under the full service delivery option, raising pension and TUPE issues.
- If the university retains any responsibility for the delivery of services, the question of how that interfaces with private sector services will need to be considered.
- The university will expect the private sector partner to meet certain performance levels, which will have an impact on pricing (the key will be the 'experience' that the students expect to receive).
So, how are student accommodation developments funded? One of the key strengths of a model supported by the university is that it is possible to move away from mainstream commercial funding into a project finance structure, which has the following advantages:
- Senior debt under a project finance structure, while more expensive than direct borrowing by the university, is less expensive than commercial finance.
- Deals using project finance require a significantly lower proportion of (more expensive) equity investment than under commercial finance.
- Senior debt rates are typically between 5 and 6% whereas equity investment attracts rates of between 10 to 15%.
The key to unlocking project finance is structuring deals using the future income stream of student rent payments. Funders have to get comfortable with the certainty of the future income stream from the student rents - certainty rather than quantum of income is the driver. Clearly, the greater the certainty of income, the less risk there will be in the deal for funders, and so the key factor that will encourage funders to agree project finance terms, with low levels of equity investment, is the extent of demand risk taken on by the private sector partner.
Unless the university puts its covenant behind the deal, the funders will assess demand risk by looking at the location of the university, the location of the campus and in particular the possibility of letting unused rooms to students from other nearby institutions or to key workers. For some institutions in major cities with multiple educational establishments, this may not be a major concern for funders, whereas in other areas it can be a major blocking factor.