By Aditi Shah
In a bombed-out investment market, student accommodation is one of the few areas with growth potential
Marc Duschenes is a busy man.
Seven months ago, the chief executive of Braemar Group launched an open-ended student accommodation fund. As of last month, the fund size was £11.03m and Duschenes intends to grow this to £100m by 2010.
It is the same story with several other funds investing in student accommodation in the UK. Some have already raised fresh equity and others plan to raise money over the next six to 12 months.
Although the values of student accommodation properties have fallen, rental income has grown on a three-year average by 5% to 10% across the UK. This growth is largely the result of the widening gap between the demand for housing from students and the lack of supply as developers struggle to raise development finance.
The weak pound is making London an attractive destination for foreign students.
The first Drivers Jonas crane survey on the sector says the number of student applications for the 2009/10 academic year has risen by 9% on this year. However, only 4,011 beds are under construction in the capital, which takes the total to just 48,672 beds for 270,000 students.
This differential has attracted private and institutional investors that are making a beeline for well-managed funds with low levels of debt and regionally diverse portfolios.
A new class
Duschenes says average yields on student accommodation are between 6% and 7%, and they will fall to between 5% and 6% over the next 12 months.
‘Other than student accommodation and agriculture, I don’t see any profitable British property sector,’ he says. ‘At a time when the wider commercial property market is suffering from rental deflation, student accommodation is able to deliver rental inflation.’
Braemar’s fund, Student Accommodation Cell, has a portfolio of two schemes in Manchester and one in Bristol. The net asset value of the fund’s portfolio is £13.77m, and it has £10.6m of debt.
Duschenes says the fund is looking at buying well-located and high-quality student accommodation in the UK’s top 20 university towns.
Last month, it bought Hotwells House, a 132-bed property in Bristol, for £6.57m, reflecting a gross annual yield of 9%. It is fully occupied and the minimum annual rent increase is 4%.
Data from Knight Frank’s student accommodation division shows that Bristol, Liverpool and Leeds have recorded the highest annual increases in rents for the academic year 2009/10 of 13%.
This is followed by Nottingham with 12% and Cardiff and Leicester with 11%. London also recorded double-digit rental growth of 10% and is on top of fund manager Cordea Savills’ ‘hot list’ of investment destinations for its student accommodation fund.
The Cordea Savills Student Accommodation Fund was launched in April 2006 for institutional investors and has a 10-year life.
It has a portfolio of 3,640 beds across 12 properties, of which 11 are income producing. One, in Birmingham, is due to be completed in September.
Patrick Carr, Cordea Savills’ director of investment and the fund’s portfolio manager, says that, although London property prices have been historically high, there are good buying opportunities now that yields are rising.
‘We want to get the timing right,’ he says. ‘If we can raise £50m of equity by the end of the year and gear it at 50%, we will be strategically well positioned to acquire assets and grow the fund.’
Cordea Savills Student Accommodation Fund was the best performer of all Investment Property Databank’s pooled property funds in 2007. Its returns of 19.72% outperformed those of the Unite Student Accommodation Fund for the first time since 2006 (see box, below).
Today, the fund’s net asset value is £61.5m.
It has net debt of £85.5m and a loan-to-value ratio of 56%. In 2008, however, it suffered a fall in capital values, and total returns were -26%. This escalated in the first quarter of 2009 when IPD recorded a further fall of 13.4%.
Carr says in terms of total returns, which is a combination of capital values and rental growth, commercial property yields have risen because of the continuing absence of debt finance and weakening occupier demand in other sectors of commercial property.
‘Rental growth across the commercial property sector is -10%, but across our portfolio it is 4%,’ he says.
‘The relative outperformance is driven by strong occupier demand from students. This differential is attractive for investors that are willing to pay high yields.’
However, a further fall in values could affect the loan-to-value ratios and Carr is cautious.
He is identifying underperforming assets that have less potential for rental growth in the future for disposal. The proceeds will help maintain the debt level and can also be used to reinvest in better-performing assets.
He says that, as long as the income return is strong, banks are not showing any signs of distress. ‘It is unlikely that there will be new banks entering thesector, but existing ones will continue to lend,’ he adds.
Another cautious fund manager is Quintain Estates & Development, which recently announced a 40.2% fall in its net asset value to 404p a share and a pretax loss of £129.1m.
It recently repaid some debt on its student accommodation fund, IQ – a joint venture with the Wellcome Trust – to reduce its gearing from 61% to 55%. It says it can withstand a 15.4% fall in the value of its fund before it needs to increase its equity level or reduce debt.
IQ’s gross asset value is £148.5m and it has drawn £98m of its £260m debt facility. Although it suffered a 14% decline in capital values, it recorded rental growth of 7.1%.
Lessons to be learnt
‘There is not much debt available for development or for investors with long-term plans,’ says Tonianne Dwyer, director and head of fund management at Quintain Fund Management. ‘This will dry up the pipeline for new schemes and the imbalance between demand and supply will get worse.’
By 2010 Quintain will have a portfolio of 4,253 beds across 11 schemes. Six of these schemes are already income producing, three will be completed by September and the other two by the following year. Its eventual aim, as stated at the time of its launch, is to take the value of the fund to £600m.
Despite the fall in property values and the lack of debt, student accommodation is attracting investors that are looking for profitable investment opportunities.
Fund managers are aware of the demand from investors and are competing to purchase the best properties. However, the lack of supply will make the competition tougher for managers such as Duschenes.
Richard Simpson, managing director of development at Unite, says: ‘The business model of strong rental growth, low voids and high occupancy is attracting institutional investors.’
He says the typical income for the first year as a proportion of the total development cost is 8%, whereas the average yield on income-producing assets across the UK is 6.4%.
Unite has a portfolio of 18,563 beds across 53 properties. The weekly rents range from £140 to £400, but most of its properties are up to £200.
It also has the largest listed fund – Unite Student Accommodation Fund – in terms of net asset value. Investment Property Databank says its NAV, as of 31 March, was £348.6m and that it had net debt of £453.8m.
The fund has suffered a fall in capital values and recorded a -9.2% return in the first quarter of 2009, and an annual return of -27.6% – worse than its IPD competitor, Cordea Savills Student Accommodation Fund.
Tim Goddard, head of Knight Frank’s student property division, says a reason for investors to look at developing student properties is the lack of opportunities to buy income-producing assets.
‘There is interest from investors in the £5m-to-£15m lot size, but there aren’t many products in the market with the right investment criteria,’ he says. ‘Whether it is private individuals or a consortium of investors, there is no appetite to invest in large chunks.’
Tonianne Dwyer, director and head of fund management at Quintain Fund Management, says that investors have a return-v-risk expectation that dictates their investment in income-producing or developing assets.
‘If investors want reliable income with a strong growth profile, and increase in income but low capital growth, they will turn to income-producing assets.
‘But, if they have an appetite to take higher risks and can manage to raise enough equity and debt, then developing student accommodation will generate higher returns.’ (Article by Aditi Shah reporting in Property Week). http://www.propertyweek.com/story.asp?sectioncode=530&storycode=3143651