Over the past few years we have taken advantage of our ability to invest in a diversified range of sectors to proactively manage the UK Commercial Property REIT (UKCM) portfolio towards income growth and security, with a focus on future fit and operational asset classes. Of particular note we have built a strong position in both urban and big box logistics, and the living asset classes, where we are invested mainly in student housing and hotels – in all of these the supply demand imbalance and societal changes continue to be highly supportive of the occupational markets and rental growth. Here we look in more detail at the drivers around investing in student housing.

Despite the pandemic-induced shock that had many spelling the end of student accommodation as we know it, the sector has bounced back dramatically. Indeed, it has proven more resilient than first imagined and many investors are now actively pursuing the sector. They are attracted to the strong demographic and structural trends that support longer-term growth in UK student accommodation demand. However, the outlook for the sector is more nuanced than many appreciate and there are a number of factors to consider before investors target this alternative asset class.

Student numbers are rising

As the number of students enrolling in UK universities has increased, so too has the demand for student accommodation. This has placed significant pressure on existing supply, with the under provision of first-year accommodation forcing some students to seek housing in other cities, or to defer their places. Applications reached their highest level in 2022, with over 760,000 undergraduate applications to UK universities. This was approximately 8.5% higher than in 2019, according to UCAS data. Despite the UK’s exit from the EU, which caused a fall in the number of EU students seeking to study in the UK, the rise in student numbers from China and India, in particular, is helping to fill the void created by their absence.

The pressure on existing stock also shows no signs of abating, as the number of university applicants is anticipated to increase over the next decade, driven by both domestic and foreign sources. The number of UK students going to university is rising and this trend is anticipated to continue. At the same time, the number of 18-year-olds in the UK is forecast to grow by approximately 20% by 2030. From an international perspective, UK institutions consistently rank among the world’s best. And the new post-Brexit visa rules, which make it easier for prospective students to live and work in the UK after their studies, are helping to ensure the UK remains an attractive destination for foreign students.

PBSA as a counter-cyclical investment

Student demand is also anticipated to remain robust, despite the weaker macro-economic environment we are entering. Recent history shows that in times of weak or negative economic growth, university application rates have generally risen. Prospective students struggle to find employment in a weak jobs market and so they seek further education to improve their career prospects.

This trend is anticipated to play out once again, indicating that student accommodation often runs counter-cyclical to the wider real estate market. Sustained student demand (with the exception of the demand shocks caused by the tuition fee increase in 2012 and the fallout from the Brexit vote) helps to spur rental value growth within the sector. Since 2007, purpose-built student accommodation (PBSA) has consistently recorded positive rental growth, despite market shocks, and has outperformed the wider real estate market in 12 of the previous 15 years.¹

Annual leases can capture rising rents

In addition, annual turnover leases in most student accommodation schemes allow landlords to capture rental value growth more efficiently – an equally important consideration during periods of higher inflation. This is particularly pertinent at present, as inflation adds pressure to operational costs. As student rents are typically on an all-inclusive basis, rising utility and staff costs are absorbed by the landlord. Therefore, the ability to review rents on an annual basis allows asset holders to more efficiently pass the impact of inflation onto tenants – thus insulating asset income profiles from the worst effects of rising costs.

That said, students are also feeling the effects of inflation, as they experience real-term falls in the value of maintenance loans. Therefore, the ability to arbitrarily raise rents annually may not serve as the panacea that many believe it to be. The affordability of student accommodation is anticipated to grow in importance in the future, and so it is crucial that investors recognise the affordability of their schemes. Raising rents may protect immediate cashflows, but the longer-term affordability of student accommodation may be more important to ensuring stable and positive returns.

Investor demand remains strong

Understandably, these factors have attracted investors to the sector. In 2022, over £8 billion of student accommodation was transacted in the UK. This was the highest total on record and accounted for approximately 14% of UK real estate transactions during the year. Investor demand for the sector in 2023 is expected to remain robust. However, limited good-quality investment stock is likely to come to the market as asset holders remain unwilling sellers. As a result, we expect to see significant competition for the limited number of assets that do make it to the market.

The lack of available investment stock will also provide a unique opportunity for the development and funding of new student schemes, but elevated construction and debt costs are expected to limit the number of viable projects. Limited investment stock and a lack of new supply will place upward pressure on asset pricing, but any rise in capital values will be capped by sustained higher debt costs in 2023.

Targeting budget-aware students

Overall, the UK student accommodation sector is well placed to continue its strong performance, but there are important considerations for investors to appreciate before committing capital to the sector. In particular, the growing 18-year-old population in the UK is bringing the issue of affordability to the fore. Chinese students have helped drive demand growth in the private student accommodation sector and traditionally have sought better-quality schemes at higher rental costs. But UK students and those from growth markets, such as India and Nigeria, appear to be more budget sensitive. Since the growth in demand for accommodation over the next decade is likely to be drawn from the UK and new growth markets, investors should be looking to target good quality but affordable schemes to protect stable income profiles.

In addition, investors should focus on schemes associated with larger and better-capitalised universities, and in locations that benefit from a limited supply pipeline. Demand for accommodation in these locations is likely to be multi-faceted and tight supply levels should support asset pricing and rental value growth, while also allowing for capital value growth in the medium term.