Anyone with university age kids will know that student digs have changed over the last few decades. I was lucky to go to a university/college that had excellent on-campus facilities but many a year was also spent in dreadful hovels which I reckon should have been shut down by the local environmental health authorities. Now my daughter is having to decide whether to pay the extra £20 a week or more to have en-suite facilities, plus the obligatory basement gym (in Northampton) – times they have a changed! Student accommodation has improved in part because of the government deregulation of the higher education sector with private capital flooding in following the boost to the number of students. But the tsunami of foreign students has also contributed mightily, and this useful tailwind currently shows no sign of abating. A long list of operators entered the student housing market, mostly following in the wake of dominant player Unite – whose shares have rerated mightily over the last few years. Most of the players in this space are now either developers or private fund managers, many from the PE world or mainstream property managers. Along with UNITE, we also have two listed student property funds, Empiric and the Gravis GCP fund. Both have a slightly different focus, with the Gravis outfit more focused on London and the really big cities, while Empiric has been happier to range widely into the second-tier cities such as Cardiff, Edinburgh and Southampton.
I’ve always been slightly cautious about these two listed funds, not because I have doubts about their ability to make a decent yield – they’ve both self-evidently been able to provide a steady 4-6% income yield over the last few years. By contrast my worries have centred on three interrelated trends. The first is that I worry that the huge inflows of foreign students will start to dry up as other countries jump on the HE bandwagon. Next up, I worry that the deluge of domestic students will also dry up as the central government tightens the screw on university finances – and considers lowering student fees (and interest rates on student loans). More pertinently I also worry that many parents will simply refuse to pay the very high rentals being demanded by some operators – and as a result shove their offspring into slightly less salubrious buildings which don’t boast all the mod cons. Lastly, I also worry about secondary market prices for these properties i.e will the building owners really be able to sell their assets on the open market for anything near the book carrying price?
I suppose I should also have added the inevitable fourth rider – its all about operational risk and execution! A great strategic narrative is one thing, but the ability to execute according to plan and build a brand is quite another thing. Unite for instance had a sticky patch a few years back as it built up its student housing brand and made the switch from a pure development focus to a more REIT like, cashflow focused outfit. Empiric has now run into a similar execution problem. Over the winter we’ve heard about a number of operational issues that resulted in a new CEO and a strategic review. As a result the shares took a big tumble, and the last time I looked were down 11% over the last year. Crucially the fund’s managers have also had to recalibrate investor expectations on the yield, pulling down the target yield for coming years to 5p per share, which is equivalent to just a bit under 6% based on the current share price of 90p.
The fund has also moved from a share price which was trading above the net asset value of all its properties to a current 11% discount – a nasty turnaround in fortunes. Is the worst over now? Some fund managers I’ve talked certainly seem to think so although I’m not completely convinced – though Empiric is also on my watchlist. Certainly, the market has given us tentative signs that sentiment is turning. Just today the share price ticked up above 90p and I also notice that a director has bought a decent line of stock this week. I’m also impressed with the radical overhaul instituted by the board and the pipeline of new developments has obviously not clogged up as we heard this morning that a new development has been acquired in Edinburgh for £7m.
In a strange sort of way I’ve always slightly preferred Empiric over the Gravis vehicle, largely because of its more provincial approach – I accept that London is a fantastic market for students but I sense that there’s more potential for a valuation uplift in the more provincial cities, where dependence on foreign students is not so all-pervasive. But if we accept that the dividend is going to come down to 5p in the £ then we need to think long and hard about that 5.7% future net yield. Given the operational mishaps, I’d want a greater margin of safety in yield terms. My own preference would be for a sustainable, ongoing yield in 2019 and beyond of closer to 6.5%. Interest rates are going up, financing costs will change and the HE sector is facing new pressures – all of which combine to add a large element of uncertainty to the market which needs to be reflected in yield expectations. In these circumstances a yield of 6.5% feels more appropriate, which implies a share price much closer to 80p. I’m also old and grey enough to know that bad news usually comes along – like buses – in threes, and I’m hugely cautious about more bad news emerging in the specialist market.
Then again, maybe I’m too cautious? Perhaps that 10% plus discount on good quality assets is enough and we’ll see the shares re-rate back the £1 level. That’s certainly the thinking of the fund managers I’ve talked to. I can’t dismiss this optimistic view out of hand but for now, I’m happy to sit on the sidelines and see if the management restructuring does deliver on the promise – and the HE sector recovers some of its confidence.