Terrell F. Gates III, founder and CEO of Virtus Real Estate, a private company in Austin that invests in student housing, is somewhat more blunt. “If you'd asked me about the strength of the sector a year ago, I would have been moderately bullish,” he says. “But today, I have a little concern about it.” These concerns involve potential oversupply, higher valuation (and lower cap rates) and people jumping into the space with little or no operations experience.

In the investment arena, notes Kevin R. Larimer, Phoenix-based Hendricks-Berkadia's national director of student housing, things are getting a little dicey. “From the demand perspective, there's a surplus of capital purchasing student housing. On the investment side, the market is more than vibrant; it's almost frothy.”

TOO MUCH OF A GOOD THING?

The picture painted by Apartment Realty Advisors' 2012 Year-End Student Housing Report is one of a hugely vibrant market. Sales activity hit a record high in 2012 at $3.7 billion in total dollar volume, with cap rates headed on a downward trajectory. Meanwhile, institutional funds and REITs dominated the class A space adjacent to campuses, while developers also jumped into the market. According to the experts, not much will change in 2013 (though the sales volume is likely to decline from 2012's record amount).

Given this information, is overbuilding a concern? Are we seeing a bubble when it comes to student housing valuations? It depends.

Specifically, it depends on the market and specific location of the developments. Bayless says that during 2012, approximately 34,000 beds came on line, with 33% of those beds opening in San Marcus, TX (Texas State University); State College, PA (Penn State); Austin, TX (University of Texas-Austin) and Statesboro, GA (Georgia Southern University). These are becoming overbuilt markets, he explains, because there are few barriers to entry and plenty of land available for construction. Basically, “student housing is lucrative and can be successful if you stay disciplined in terms of asset quality, related to proximity to campus and interior submarkets, and are mindful of barriers to entry,” Bayless points out.

But Larimer acknowledges a concern with these and other markets. Namely, developers might be building to the amount of capital available in the market, rather than building to meet demand. “All things are positive from a demand driver on the student side,” he says. “But the biggest concern is when there's a surplus of capital out there, deals are getting done due to capital, rather than demand.”

Speaking of capital, for much of the Great Recession and its aftermath, Fannie Mae and Freddie Mac were willing to put money into student housing projects that made sense. In other words, projects that were owned and operated (and developed) by those who knew what they were doing and who had a track record. These days, there are other options for debt, such as the conduit markets, life companies and pension funds.

Dinerstein allows that there is plenty of debt out there, as does Larimer. “We'd like to see construction debt maybe a little less available, but it doesn't seem to be a problem so far,” Larimer observes.

In fact, according to Chris Epp, co-director of Apartment Realty Advisors' National Student Housing Group in Austin, conduit financing seems to be coming into its own. “We saw a group that, two months ago, took down a building with a conduit,” he says. “They weren't strictly first-timers, but they weren't seasoned either.” Fannie and Freddie were interested, but as the conduit was more aggressive, “the conduit won out,” Epp comments.

Gates sounds a more cautious note to debt and capital availability, pointing out that in late 2012, Fannie Mae and Freddie Mac slightly changed up their lending policies. In short, the agencies indicated they aren't going to close many deals during the preleasing period, unless the lease rate is well on track or ahead of previous years. “They saw some softness last year between what was preleased and what actually delivered,” Gates comments.

Epp acknowledges this is the case, and one of the reasons why conduit lending is starting to become popular. Buyers who need to have a deal done immediately are not going to wait around for the GSEs that might want to see a project 100% preleased before putting money on it. So “while Freddie and Fannie continue to be your go-tos, we're seeing an real emergence of conduit lenders,” he says.

And with more capital out there than available assets, the fully amenitized core assets—complete with all the bells and whistles and are located near campus—are likely to drive up the commercial real estate value. As such, “we'll continue to see cap rate compression, especially as interest rates remain low,” Larimer predicts, adding that, as 2012 was a huge year as far as sales activity, the total sold during 2013 will likely be lower. Maturing debt will be a further factor down the line; the ARA Student Housing report points out that the next few years will see a plethora of nonperforming loans maturing, especially in 2016 and 2017.

LOCATION MATTERS—TO A POINT

Student housing's general mantra has been that the closer it is to campus, the more successful the project. In some cases, the housing is successful even before it comes online. As an example, Epp says that Catalyst, which is being developed by Chance Partners LLC to serve Florida State University in Tallahassee, is under construction, and is, in his words “a mudbath.” Scheduled to open in fall 2013, “kids have been coming in and signing leases without being open,” Epp says. The same situation is happening with Asset Campus Housing's Domain at Fayetteville, developed to house students attending the University of Arkansas. Despite the fact that Fayetteville is becoming an overbuilt market, this project—to open this fall—is also attracting a lot of students. “The kids are loving the newer, nicer stuff that's a unique product,” he says.

But things change once you get even a few miles away from campus. The luxury products that aren't adjacent to, or within walking distance of, campuses are the ones that are starting to see a drop in occupancy. “The expensive stuff that's away from the campus, not in that irreplaceable location—those are the properties that are at the most risk,” Gates comments.

This is because kids who aren't on or near campus are more interested in value, rather than luxury. Developers entering rural college towns and offering an urban high-rise product may encounter some difficulties. “If you're a student that can live in a three-story, stick-frame luxury complex, I don't think you'll want to pay a $200 premium to live in a commercial high-rise product in that same market,” Bayless observes.

Yet the experts caution that it's tough to make blanket statements when it comes to what will work in student housing and what won't. Ted Rollins, co-chairman and CEO of student housing developer and owner Campus Crest Communities Inc. says student housing trends are vastly different between flagship markets and smaller ones. The softness may not be quite so prevalent in a place like the well-known University of Texas at Austin. Anyone building or owning there, especially as close to campus as possible, should do well. However, “not a lot of people may want to attend Midwestern State in Wichita, TX,” Rollins says. In those locations, he notes, student housing properties won't fill up as quickly.

A NEW POTENTIAL MARKET

Though the traditional focus of student housing is four-year campuses, some developers and investors are eyeing potential housing on commuter college, community college and junior college campuses. Virtus, for example, is working with San Antonio Community College on housing. Gates points out some very good reasons for this. While at one time, community colleges were the domain of students who couldn't get into traditional four-year programs, economic realities have changed things.

“Those are no longer the schools of last resort,” he says. “Students might go in for programs that don't require a four-year degree.” Also, with the costs of a four-year education increasing, “kids might attend these schools to get the basics out of the way at a lower cost, then transfer to a four-year program,” Gates says. Rather than living at home, students are gravitating more toward campus-oriented housing, and Gates believes this is spurring the need for student-specific housing.

This doesn't necessarily mean that the next big student housing wave will be toward the community colleges, however. “We're selective about where we're going,” Gates says. Rollins, whose company is not involved with development on these types of campuses, acknowledges that these are “fringe” markets that can work on a case-by-case situation. “It depends on the culture of the region,” he says. “If it's just commuter, you need to see if it's transitioning to a full-time school.”

Others are more skeptical. Larimer, for one, points out that most kids attending commuter schools or junior colleges are doing so to save money and live at home, rather than to try to find something on campus.

Bayless also cautions that while satellite and commuter campuses are seeing good growth in terms of enrollment, the markets have fewer barriers to entry and could be impacted by more volatility than the standard four-year colleges or university. As such, oversupply and overbuilding could occur.

Still, if done judiciously and carefully, such on-campus living arrangements could be successful for student housing developers and owners. “High net-worth individuals or a syndication group might see an opportunity in that market, and the return on yield is higher for them,” Epp comments. Cap rates are likely to be higher among such housing, since more yield is required, he adds, “But the institutions aren't likely to focus there.”

THE END RESULT . . .

The student housing market is not on the verge of collapse. In fact, it's nowhere near collapse. Rollins points out that, despite concerns over issues such as student loans and increasing tuition, college is still the destination for the majority of high school graduates, meaning living quarters will continue to be supplied to students. Immigration into US schools will continue, he points out. Furthermore, “If you look at the average stay of students, they're staying longer in school, which will help keep enrollment growth fairly robust,” Rollins adds.

The experts do agree that this is a maturing industry, and some things need to be watched. Overbuilding is a concern, as are inexperienced developers and owners jumping into the market.

“We're concerned because a lot of people are jumping into the space and valuations are increasing dramatically,” Gates remarks. “We're concerned about how much attention the space is attracting from a cap perspective.” These trends, combined with new construction starts and plans, bear watching over the next couple of years.