So, which real estate asset classes do property lenders still favour, even as the country tips into recession, inflation and interest rates continue to rise and the IMF continues to pronounce on our economy?
The answer, for us at least, is residential plus under-supplied areas of both offices and industrial property, because location and covenant strength still count for a great deal in spite of the uncertainty that lies ahead. As does the quality and track record of our underlying borrower.
Build-to-rent investment and development specifically remains a resilient prospect, given fast-rising mortgage rates and a continuing shortfall of new housing completions are making home ownership even more elusive to so many. This is compounded by a shrinking buy-to-let market, as mortgages secured in the mid-to-late 1990s expire and new government regulations eat into returns for owners.
But one other sector continues to offer stability and defensive returns, even in these uncertain times for its sheer resilience come rain or shine: purpose-built student accommodation (PBSA).
There is a reason why Unite Students recently joined Segro, Landsec and British Land as the fourth FTSE 100 property company: its portfolio is rock solid, boasting sustainable rental growth of 3-3.5% a year and a 5,000-bed development pipeline.
PBSA remains a favourite target of ours because:
And above all, universities are still hungry to invest in new facilities. According to Cushman & Wakefield, investment in university academic facilities is expected to exceed £7bn between 2020 and 2025. New bed spaces also need to be delivered to match future anticipated growth in demand
- Even during the Covid-19 pandemic student numbers and applications to university rose sharply as people upskilled with their employment prospects under threat. Many students postponed gap years from before to after their degrees
- Overseas student numbers are soaring again, with 80.7% more visas issued to students in 2021 than in 2020. This demographic is important when assessing demand, as foreign students most often favour PBSA while studying in the UK
- Overseas students are popular with developers and investors because they tend to pay six months’ rent up front. This is because their parents, based overseas, are unable to act as guarantors, and so sometimes even pay for a whole year’s accommodation upfront
- The weak pound means rents and living costs are very reasonable for overseas students compared with studying at home
- More second- and third-year students are now staying in purpose-built halls (with all their costs included), rather than moving into house shares, to better manage their budgets given the £9,000 a year they spend on tuition fees
- Developers also have a year-on-year ability to mark to market rents, acting as a good hedge in this inflationary environment – albeit for only as long as students are willing and able to burden sky-rocketing costs
- And above all, universities are still hungry to invest in new facilities. According to Cushman & Wakefield, investment in university academic facilities is expected to exceed £7bn between 2020 and 2025. New bed spaces also need to be delivered to match future anticipated growth in demand
- Location, location, location – as a lender we will want to know it is the right kit in the right place, such as universities that are structurally undersupplied and continue to see high demand for applications.
The ideal scenario for a lender – and any developer looking to de-risk – is to secure a “hard” nominations agreement, whereby a university leases the bulk of the apartments in a development for first-year accommodation. That said, although this will be reflected in the equivalent yield, a developer will trade away the ability to manipulate rents in this scenario.
This is effectively a major prelet backed by a quasi-public sector guarantee, which is probably a better bet than an office occupier that might be considering downsizing, a retailer battling to fend off Amazon or a warehouse owner with a tenant whose rent has sky-rocketed.
However, supply of student accommodation is tightening all the time. The number of new developments delivered in 2021 was 69, less than half the level in 2017.
Rising land values and construction costs, complex planning negotiations and a tighter funding market are only going to make delivery more difficult in the next three years, but as a stretched senior lender we have lent £1bn to the student sector and will continue to provide finance.
In the current volatile conditions, it is simply one of the most resilient real estate asset classes of all.