The Canadian Student Housing Market?

Jonathan Turnbull, Managing Partner at Alignvest Student Housing, sent me a guest comment on insitutional grade student housing investment opportunities in Canada:
Student Housing is a specialized segment of the residential real estate sector and is broadly defined to include multi-tenant housing designed to accommodate students enrolled in post-secondary education.

Student Housing is a well-known sector to global investors who have invested over $15 billion a year since 2015 acquiring properties all over the world (current year volume expected to be similar).

The segment has evolved into a $200 billion market because of two major long-term statistical trends and one fundamental shift in consumer behavior.

Major statistical trends:
  1. global student enrollment growth far exceeds global population growth because of (a) the growing importance of a post-secondary education and (b) the growth of the global middle class and mobility of international students; and,
  2. universities/colleges have directed their limited funding towards academic capacity growth and not new on-campus beds.
The increase in demand for beds has not been met by traditional supply and the market has turned to the private sector for new beds.

The shift in student/consumer behavior:

The typical student (and their parent) is seeking a different experience for their post-first-year school accommodations – one that is safe, community-based, offers high-quality living accommodations, student-oriented amenities and a productive learning environment given the importance (and cost) of the education. Around the world, we have watched as students have moved away from traditional off-campus housing (shared homes, basement apartments, cheap/cramped spaces) to new, secure, modern, highly-amenitized accommodations within walking distance of school.

The student housing sector has experienced tremendous growth in demand over the past 20 years which has been matched in certain markets by a similar growth in the supply of private beds. The typical institutional grade off-campus student housing currently being built offers its tenants high-quality accommodations that caters to students’ increasing demands, including: close proximity to campus, high-end design and common areas, secure/safe design (individual key-fob access), fully furnished private bedrooms, private bathrooms, shared living/dining/kitchen area for 2-5 tenants equipped with high-end appliances and furniture, in-suite laundry, high-speed internet access, common areas/cafes, study areas, board rooms for collaborative studies, games rooms, theatres, exercise facilities, etc. The environment created by the facilities and the operator make the students “want to live in these new facilities” relative to the older, more traditional housing options.

In addition to supply growth, the sector has experienced a tremendous improvement in its investment and operating expertise (learning from mistakes) that has de-risked the sector dramatically over the past decade. The original investor concerns about the student housing sector (including the perceived risks of high annual turnover, low tenant quality and high risk of property damage) have been eliminated by strong and consistent operating performance. The original concerns have been replaced by the reality of almost 20 years of operating history:
  • High turnover risk can be managed proactively by good operators
    • Turnover is known early in the lease cycle - vacancy rates have been consistently low
    • 12-month tenant leases have become the norm (vs 8mos)
    • Turned into a positive – easier to drive topline growth (new tenants at market price)
  • Parental guarantees make the tenant quality better than typical residential real estate
  • Student behavioral shift & investment/operating strategy has reduced risk of damage
    • Cost of school and importance has changed mindset of the average student
    • Furnished suites & security cameras (combined with parental guarantees)
The net operating results speak for themselves - 50 consecutive quarters of same property revenue growth, lower revenue and net operating income volatility than multi-family apartments as well as lower market correlation compared to various real estate asset classes.

The sector’s long-term macro opportunity and results-to-date have attracted substantial global investment into the sector. The ownership structure of the sector has changed dramatically with smaller owner/operators being consolidated by larger entities which have, in turn, been purchased recently by global investment leaders that have pushed valuations to all-time highs.

Valuations have tracked the market’s perception of the business opportunity – shifting from being ‘at a discount’ to the multi-family sector to be priced equal to or at a premium to the multi-family sector. Recent large-scale acquisitions have been completed at historically high valuations despite expected near-term interest rate increases because investors believe the sector can disproportionately grow its cash-flows due to the proven operational element of the business (click on image).

The Canadian Market

The Canadian student housing market is one of a few in the world that has yet to attract substantial institutional capital to consolidate and grow the business.

Market fundamentals are strong -- Canadian student housing supply/demand dynamics are as attractive, if not more so, than its OECD peers. Canadian university population growth is faster than established markets such as the US and UK, driven by increased local student participation and Canada’s disproportionate share of the growing international student population. Similar to their global peers, Canadian universities do not have the capital necessary to build new beds to service the increased demand and therefore more off-campus beds are needed every year in university cities/towns.

Supply limited to date -- Historically that increased demand has been met by traditional student housing options such as low-density home rentals as well as basement apartments. The large-scale development of purpose-built student accommodations has not yet occurred in Canada for various reasons. Local developers and investors have built 30,000 total PBSA beds (3% of student population) in attractive ‘pockets’ around the country but the ownership is fragmented and often in the hands of short-term sellers (developers vs owner/operators). Annual new purpose-built construction is estimated to provide under one-third of the total new beds required from increased enrollment at universities in Canada.

Investment opportunities have been limited to date -- As outlined above, the lack of institutional capital focused on the sector has restricted the development of high-grade / high-governance investment vehicles focused on consolidating and growing the fragment industry. Large real-estate investment firms have been cautious to invest given the heavy operational element of the business.

The largest real estate investors in Canada, the pensions, have shown a love for the sector in other countries; however, those investments have been in fully consolidated markets into operating companies worth hundreds of millions/billions of dollars. The roll-up strategy in Canada (aggregating a large portfolio of $10 - $50 million buildings) could prove to be an attractive long-term strategy for a real-estate investment team that understands the operating element of the business and is able to be a first-mover into the sector as current valuations in the sector are still at substantial discounts to local multi-family apartments. The investment sector is a proven winner in markets around the world and should be as well in Canada.
I thank Jonathan Turnbull for writing such an insightful comment on the Canadian student housing market.

Jonathan is right, Canada's large pensions have invested billions in student housing around the world but mostly in the US and the UK. In 2017, I wrote a comment on CPPIB and GIC betting on US college housing, but PSP and other large pensions are also big investors in this space.

I take a bit of a macro/ thematic view when it comes to student housing over the long run. In particular, the world is becoming ever more competitive, rising inequality will continue, wealthy families around the world are sending their kids to universities in the US, UK, Canada, and elsewhere and they want to know their children are safe and enjoy the best amenities so they can focus their attention 100% on learnng and doing well in school.

In other words, student housing has secular winds supporting it, and it's relatively recession-proof because even during an economic downturn, parents will do everything to send their kids to university to learn.

Having said this, like all investments there are risks here too. Jonathan touched on a lot of them. Valuations are rich, interest rates might rise (I doubt it), and student housing has been a notorious nightmare for property managers in the past (but these issues are being addressed properly now).

As far as Canada, the only other fund I can think of in the space is Centurion Asset Management based in Toronto and founded by its President and CEO, Greg Romundt (a former derivatives trader and one hell of a sharp guy).

But Centurion doesn't exclusively focus on student housing, it also focus on multi-family residences and the fund caters mostly to retail investors (it's RRSP eligible) but it also has institutional investors.

Other issues in Canada? In 2016, an article described how Waterloo is facing sizable glut of student housing:
The oversupply of student housing in this city is far worse than previously thought, says an expert who tracks the investment real estate market.

One of the new student apartment buildings in the university town already is in power of sale proceedings, Karl Innanen, managing director of the Waterloo Region office of Colliers International, said Wednesday.

Currently, there is an oversupply of nearly 1,200 beds, but when new developments that are in the works are included, the surplus increases to 8,321 beds, Innanen said during the commercial real estate firm's presentation of its annual report on market trends.

Innanen said the Colliers analysis does not take into account increases in the student population because the University of Waterloo, Wilfrid Laurier University and Conestoga College are forecasting low single-digit growth in enrolment.

That rate of increase won't be nearly enough to absorb the extra beds, he said.

There are 41,440 university and college students in Waterloo, Colliers said. When you take away students who commute to campuses, that number drops to 31,429.

The Waterloo skyline is dotted with construction cranes for student apartment buildings. When those buildings are completed, the supply of beds will overshoot the market by 20 per cent, said Innanen.

"I think the student market was overbuilt because people got overzealous and there was no discipline," he said in an interview. "Unfortunately, it was a rampant supply of brand new, nice buildings."

Innanen believes newer buildings with modern amenities that are close to the campuses will remain full. That will create problems for student apartment buildings that are not as nice and not as close to the campuses.

At least one recently built student building is now in power of sale proceedings — a forced sale by the financiers to recoup their investment after the owners fell behind in payments.

"That is not a good sign at all, and we expect to see more of that, unfortunately," Innanen said. "There are going to be some real challenges going through that."

Buildings in power of sale proceedings typically sell for lower prices, which creates opportunities for other investors. But the oversupply is a complex problem to unravel, he said.

The buildings "are new, they are nice, they are attractive," he said. "Will they be in places where nonstudents want to live? Will they be in places where young professionals want to live? Possibly. We will have to see how that evolves."

Some of the student apartment buildings contain five-bedroom units. "To convert a five-bedroom unit into a two-bedroom or three-bedroom unit for a family to move into is also difficult," Innanen said.

And mixing students with nonstudents could be problematic. "Will a family want to live in an area that is predominantly a student area?"

But City of Waterloo planners are optimistic the Northdale neighbourhood, where many student apartment buildings are located, will evolve into a mixed use area with a variety of residents.

In recent years, about $600 million was invested in new, multi-unit housing in that area, said Ryan Mounsey, a planner in the city's economic development office. Between 33 and 50 per cent of the residents in the new buildings are nonstudents, he said.

The city spent millions on new streets and parks in Northdale, and changes along nearby streets should also have positive impacts for the student-dominated area, said Mounsey.

The arrival of light rail transit next year and the evolution of the Phillip Street corridor into the Idea Quarter, consisting of a mix of technology companies, retailers and residential developments, will also attract nonstudents to that part of the city, he said.

The market for student apartment buildings was the only dark spot in Collier's report on real estate trends in the region.

Last year was the second best year on record for real estate investment, with more than $900 million in investment sales. The surge in investment was driven by demand for apartment properties.

"This year there were more than $300 million in sales of apartment buildings," Innanen said. "That's three times a usual year."

As the local investment market has grown the type of investor has changed.

"We have institutional investors here now," Innanen said. "We have REITs (real estate investment trusts), pension funds, groups that buy big properties."

Toronto-based Allied REIT and San Francisco-based Spear Street Capital both moved into the region's real estate market in significant ways in recent years.

"Those big, blockbuster deals have really changed the market and made everybody look at this market," Innanen said. "It is certainly secondary to the prime markets across Canada, but it is not one that anyone overlooks anymore."
I had sent this article to Jonathan Turnbull back in July and he was kind enough to share these views with me prior to writing the guest comment above:
I think the Waterloo market, as the largest PBSA market in Canada, is “full of stories”… We have seen many versions of this story over the past couple of years and have done our own extensive diligence on the market (including the development of a proprietary database of over 180 different student oriented rental buildings close to the two schools) and have a different view than the author of the article. We actually think negative articles/comments is to our advantage – keeps others away from the largest and possibly best market in the country that is growing by 1,300+ new tenants each year (students at WLU and UW).

There is negative press in the Waterloo market about being over-built…we believe the commentary is being driven in large part by (1) owners of second/third tier beds that use to command $500-600/bed/month as well as (2) certain owners/investors of recently built condos focused on renting their 1-2 bedroom units to students that have experienced a decline in rental price per bed. Group (1) tells everyone the place is over-built because they are no longer getting the rents the once did - they are being squeezed out because of quality/location whereas quality PBSA assets are 95%+ filled with growing rental rates. Group (2) investors are talking about the decline in monthly rents because their ‘2 years of guaranteed monthly rental streams (set artificially high by the project developer to attract investors) are expiring and the $950 a bed they use to get (funded by the developer) is now at market rates ($850)…demand at market rates is firm as students never paid $950/bed.

Analytical View:

Happy to discuss hard-core numbers/analytics surrounding (1) the growth in Waterloo’s student population (higher numbers than in the article), (2) the decline in commuting student percentage given the increase in out-of-province and international student %, and (3) the substantial decline in licensed rental beds (from 12,000 to 5,000) in the entire Waterloo market (driven by the better/safer/closer options provided by the growing PBSA market). We have dedicated substantial resources to such proprietary work. There is also another trend we are experiencing globally  a fundamental shift in the characteristics of what students are looking for in their accommodations which is a powerful trend which benefits new, institutional grade buildings with student oriented amenities. The days of being happy with an old basement apartment 2 km from school has been replaced with the current generation of student’s desire to live in a nicer student oriented apartment close to school.

Practical View:

If things were over-built…the following would NOT hold true. The building we are closing in mid-July is 99% occupied for sept-18 to sept-19 (with 12 month leases at an 8% average increase in NEW Leases). It has been almost 95% occupied for the 2018/19 school year since Feb 8 of 2018…effectively sold out in under two months. We are in negotiations with 3 other class A PBSA buildings in Waterloo: one is 99% pre-occupied for the ‘18/’19 school year and the other two are both over 96%. I am aware of two other properties for sale that I am not a big fan of (don’t like the location) – one is 100% occupied and the other is 90-91%. If the market was over-built, we wouldn’t have been 95-98% occupied THAT quickly at 8% higher rents

The converted low-density homes are being squeezed out and they are no longer renting to students (12,000 licensed beds now closer to 5,000). Those ‘lost’ homes are likely now being occupied by families/young professionals (growing market similar to student). Pricing has remained firm for high-quality PBSA over the past few years during the surge in construction (supply has been absorbed by student growth, elimination of licensed rental units and the shift in student preferences/budgets). Lastly, there is limited additional construction ‘space’ in areas close to the school – helping ensure the pricing leverage will stay with the high-quality PBSA that is currently close to the school. The current rental market environment for high-quality PBSA close to the school should therefore remain firm for many more years.

The below graphic highlights the typical US PBSA occupancy pattern during the year…I have layered on the asset we are acquiring in Waterloo to give you a sense of the quality of the asset and the market demand. It shows that the average US market ‘fills-up later in the year’ than our soon to be acquired asset.

Once again, I thank Jonathan Turnbull of Alignvest Student Housing for providing my readers a lot of great insights on the Canadian student housing market.

I know this is a very popular space but Canada has some catching up to do relative to the US and UK, so I would advise my readers to discuss further with Jonathan if you require more details.

Below, marble countertops, stainless steel appliances, individual bed and bathrooms, a pool and hot tub - that's what you'll find at the two new student housing complexes at University of Louisville. Students are looking at colleges with an eye on where they'll live on campus and UofL is building the high end apartments to compete for top students.

Yeah, things have changed a lot since my time at university and I doubt there are any student housing complexes in Canada that compare to this but I may be wrong.

Still, student housing is a big deal to attract foreign and domestic students to a university, so keep an eye on this market abroad and at home.