Is the student accommodation market in a bubble?

Last week, many A-level students celebrated as they received the grades needed to get into their chosen universities. The companies hoping to be their future landlords are also celebrating. 

Following the most testing 12 months for the listed real estate sector since 2008, the market for purpose-built student accommodation (PBSA) is booming. MSCI data reveals that last year the asset class attracted more investment than retail assets for the first time, driven by institutional buyers. And while other kinds of real estate assets have recorded drops in value and investment levels, PBSA continues to attract waves of cash.

The two big PBSA real estate investment trusts (Reits) are reaping the benefits. Empiric Student Property’s (ESP) better-than-predicted interim results caused its share price to jump earlier this month. The month before, Unite (UTG) posted similarly bullish results alongside the announcement of its £300mn equity raise, the first real estate placing of more than £50mn in more than 12 months.

A combination of record-high university admissions and low supply is driving the investment. Overnight queues for limited accommodation are terrible for students, but for landlords, it shows the depth of demand in the market, and they are hiking rents as a result.

But with investors and developers pumping so much money into new student accommodation, the question shifts to the potential for oversupply. Meanwhile, calls for rent controls, tougher government rhetoric on immigration, and the rising costs of university attendance could also theoretically inhibit demand. 

University challenge

Student accommodation website StuRents calculates that there is currently a shortage of 283,000 student beds in the UK, and forecasts that this will rise to 621,000 by 2026 based on the number of PBSA buildings in the planning stages and further surges in student numbers. 

Richard Ward, head of research at StuRents, said a combination of local demographic changes and more international students arriving had driven demand higher.

When the UK opened its arms to immigrants from Eastern Europe in 2004, thousands took up the offer and either brought their young children to the UK with them or have had children since. Many of those children are now passing their A-levels and applying to UK universities.

The second factor is the rising popularity of UK universities among international students, particularly those from China and India. As the world’s two most populous countries industrialise, those students and their families are attracted to the UK’s universities because of their prestige – with the UK home to five of Europe’s six best universities, as per The Times Higher Education World University Rankings – and because the UK immigration system is less arduous than that of the US.

International students make up about half of Empiric’s tenants. Meanwhile, Unite leases half of its portfolio to universities and the rest directly to students. Of its ‘direct let’ portfolio, half of its tenants are international, largely from China.

Demand has combined with a lack of supply. Homes in the multiple occupation (HMO) landlord market, which once housed large numbers of students, is not keeping up with the growth in student numbers. This is partly due to councils’ dislike for the sector, with many having introduced effective bans on buy-to-let landlords turning their homes into HMOs for students or young professionals. Interest rate hikes and legislative changes are also pushing some private landlords out of the market.

PBSA operators have jumped in to fill this gap, but catering to the demand is not easy, with developers complaining about a restrictive planning system, rising construction costs, and the recent spike in debt prices. Indeed, Unite said high interest rates are part of why it chose to tap the equity market for £300mn for development instead of going to the banks. For companies such as Watkin Jones (WJG), which makes its money from building PBSA and selling it, the difficulty of delivery has caused problems.

However, for the companies that already own a lot of PBSA, such as Unite and Empiric, the problems can be seen as a good thing. The supply crunch might hamper growth in one sense, but it also keeps demand high and allows them to increase rents for the next academic year by 7 per cent and 9 per cent, respectively – the latter “significantly ahead of previous guidance”, in the words of Empiric boss Duncan Garrood.

Tough lessons

These rent increases have not gone unnoticed. Prominent politicians, including Manchester and London mayors Andy Burnham and Sadiq Khan, are calling for rent caps across the private market. Scotland has already done so for private mid-tenancy increases. If rent caps move south of the border, they would push down Unite and Empiric’s profits.

Even without caps, the rising cost of university generally, as maintenance loans and grants fail to increase in line with inflation, also threatens the PBSA market. It could encourage some students to stay at home while they study and others to skip university altogether. Demographic changes might also hit future demand, with StuRent’s Ward observing that the surge in the number of young people turning 18 between now and 2026 will begin to slow down and then reverse after that.

And although demand outstrips supply nationally, Ward said there was alreadly some evidence of oversupply in particular markets, questioning the large accommodation pipeline in cities such as Nottingham and Leeds. “Would I say they are bubbles? No, but certainly there are risks associated with those locations if too much stock is delivered too quickly,” he said.

Oversupply, while still a regional affair, represents a greater operational risk for PBSA than other real estate asset classes. Tenants sometimes sign leases for offices, warehouses, or shopping centres before a developer even puts a spade in the ground – known as a ‘pre-let’ – and the contract could be in place for decades. By contrast, PBSA is leased to students one year at a time and only when the building is complete.

Unite manages some of this risk by signing nomination agreements with universities, which underwrite the leases were student demand to fall off a cliff as it did during the Covid-19 pandemic, but this only covers half of its leases, and does not apply to Empiric.

Letting its whole portfolio directly to students gives Empiric the power to increase rents more than Unite in good times, but also leaves it more vulnerable in more difficult periods.

There are other risks to watch for. Overseas demand could be challenged by the rise of East Asian universities, with two Chinese universities and a Singaporean university in the global top 20, and by the UK government’s increasingly tough stance on immigration. While some argue that policies such as the restrictions on students bringing their families with them are unlikely to impact the demand for single-bedroom PBSA, which the likes of Unite and Empiric develop, academics worry that the general tone of the government’s anti-immigration rhetoric will drive overseas students away, particularly masters and PhD students.

Another issue for PBSA is post-Grenfell fire safety costs. The government has already pushed housebuilders to commit billions towards fixing the problem. In their recent results, Unite and Empiric admitted their fire safety costs have increased beyond their initial estimates. The pair are eager to pass the costs onto the contractors, who they argue are to blame, but final costs could yet increase further.

These bear points could slow down the PBSA market. According to traditional market dynamics, extended shortages drive up prices, which then cut demand and lower prices in turn. But the size of the gap between the number of beds and the number of students looks high enough to carry the sector for at least a few years. While Covid has already shown how impacted Unite and Empiric can be by a sudden change in demand, it has also shown they can recover quickly. This points to continued strength for both companies.