Fundamentals
Overall, operating fundamentals are expected to remain strong in 2023. An important indicator is that pre-leasing levels (and year-over-year rent growth in pre-leasing) and rental rates are at record-high numbers and current occupancy is strong, which supports the continuation of a strong fundamental operating trend for this asset class.
New supply has been limited compared to historical trends, given high construction costs, availability of land, and availability and costs of construction financing. Supply is not keeping pace with demand as evidenced by >90% occupancy at some universities and double-digit rent growth. The hottest markets are the large Tier 1 public universities in the Power 5 (ACC, SEC, Big Ten, Big 12, and Pac-12), where enrollment trends remain strong. There is a growing gap between fundamentals at top Tier 1 universities and those at smaller Tier 3 markets, where enrollment and applications are falling.
Capital Markets Activity
In terms of investor interest, we continue to see new institutional capital entrants in the sector (both domestic and international) and that trend is expected to continue as institutional investors increase allocation to the sector. While there is investor interest, there has been a lack of product for sale the past few quarters. Transaction activity is down in the first part of 2023 given bid/ask spread between buyers and sellers. Cap rate expectations have risen given the cost of debt, but sellers have been hesitant to reduce expectations and are not pressured to sell because properties are operating so well. As such, developers are content to focus on growing revenue and net operating income.
Capital is readily available for this asset class, but the cost of debt and equity has increased as the capital markets have adjusted yield expectations. Long-term financing is available from agencies and life companies, but construction financing is much more challenging to obtain from banks today, which will further limit the supply pipeline.
Outlook
In the next few years, fundamentals are expected to remain strong. Rent growth will likely moderate to more normalized levels. Market participants expect transaction activity to increase later in 2023 and into 2024 as the market gets line of sight into peak interest rates, seller expectations are adjusted, and developers elect to sell as their best option versus financing options available to them on a refinance.