InfraRead Issue 8 19 Sep 2016 Australian student accommodation transactions

The final quarter of 2014 saw a number of high-profile deals reach close in the New South Wales infrastructure market, including the A$8.3bn North West Rail Link Project, the A$2.2bn Sydney Light Rail Project and the A$1-2bn Northern Beaches Hospital Project.

In this wave of “mega deals”, the achievement of financial close on the University of Wollongong’s A$270,000 student accommodation transaction attracted little publicity. Eighteen months on, however, and the impact of the Wollongong transaction is now being acknowledged, and is being seen by many as the catalyst for a wave of student accommodation transactions that comprise one of the hottest infrastructure sectors in Australia.

Apart from transactions being procured by universities themselves, which are the subject of this article (and which, in Australia, are attracting infrastructure investors such as AMP Capital, Capella, DIF, Infrared, John Laing, Morrison & Co. and Plenary along with operators such as Campus Living Villages, UniLodge and Urbanest) there is also a Riding the wave: Australian student accommodation transactions by Harvey Weaver, Melinda Harris and Philip Vernon wave of property developers (both domestic and international) who are adding student accommodation to what would otherwise have been more traditional residential or commercial property plays in and around key areas for students such as Brisbane, Melbourne and Sydney.

This article highlights the key issues faced by universities, sponsors and financiers in developing on-campus student accommodation transactions. It also provides points of comparison between the structures used in Australia and the more mature UK market.

Characteristics of the transactions and key drivers

The transactions currently in the market (such as La Trobe University and Curtin University) and those which have recently closed (e.g. Australian National University (ANU)) usually involve an up-front payment from the project company to the university. This is in return for the right to receive rental income paid by students and certain other revenues derived from a defined set of residences over the life of the transaction, typically between 30 and 40 years. The project may also involve the construction of new residences by the project company or by the university, on-campus accommodation being generally preferred as this ties in with the overall university experience – a key differentiator when compared to the private rental market. The rental streams from these new residences usually form part of the transaction. 

UK Perspective: in the UK there is generally a mix of on-campus and town centre accommodation. Town centre accommodation may sometimes be perceived by investors as having an advantage over campus accommodation, as it may have enhanced alternative use options and a greater residual value in circumstances where funders may be required to exercise security over the assets following a termination scenario.

In terms of services (discussed in more detail below), the project company will generally perform facilities management services at both the new and existing residences (Hard FM). The university may contract out, or retain, student-facing type services such as pastoral care, applications for accommodation and internal cleaning, etc., (Soft FM), with the model selected being driven by the requirements of the particular university. The university typically retains marketing responsibilities for the student accommodation, as this ties in with the marketing of the university and allocation of student places more generally, and it is commonly accepted that the university is best placed to manage this. Given the link with demand, marketing is a key area of focus for the project company and its lenders.

In general, the structure of the transactions is best described as a form of hybrid PPP. While in many of the transactions the overall style of documentation and risk allocation bears many of the characteristics of a PPP transaction, these are not transactions awarded by a state government, as would be the case in a PPP transaction, and there is no availability type payment. While occupancy support, if any, may potentially underpin a degree of revenue (and therefore give financiers comfort), the project company still takes an element of demand risk, coupled with some exposure to rent adjustments.

While the above sets out a general approach, in practice the structure of each transaction very much depends on the university involved and its key drivers. For example, when formulating a view on the university itself, the following factors are seen as important to the strength of a long term partnership:

• its reputation (including if it is a member of the leading “Group of Eight” universities in Australia);
• location and number of campuses (e.g. close to the central business district of a city, spread over a number of campuses or on one site);
• student numbers and target profile at the university;
• financial standing (many universities in Australia have credit ratings);
• the kind of courses offered at the campus at which the residences are located;
• overall demand for accommodation at the relevant campus (historic and projected); and
• projected level of future expansion (offering the private sector an opportunity to deploy further capital in the future).

UK perspective: similar considerations apply in assessing the creditworthiness of a university in the UK (the Russell Group being an equivalent to the Australian “Group of Eight”) but UK universities do not typically have credit-ratings. The UK Guarantees scheme has been used in circumstances where it has been more difficult to raise finance, i.e. the University of Gloucestershire’s Pittville Campus project.

The structure of each transaction is heavily influenced by the key drivers for the particular university. In some cases, a key driver is to maximise the value of the upfront payment from the project company, (for example, if the capital is earmarked to be used to reduce outstanding debt, or for other projects at the university such as new academic and research facilities). In other cases, the principal driver may be the provision of new accommodation (if the current student accommodation stock is aged and/or there is immediate demand for new accommodation) or the introduction of private sector expertise into facilities management, with an up-front payment being less of a factor.

Depending on the size of the transaction, an up-front payment may not be realistic, (for example, if the number of existing residences is low and the project company is being asked to fund the new-build accommodation). For some universities, achieving an “off balance sheet” treatment for the transaction is important so as to free up (or not constrain) future borrowing limits – this needs to be factored into the structuring at an early stage.

UK perspective: in the UK it is the norm for student accommodation projects to be off balance sheet.

Key issues during construction

As mentioned above, some transactions require the project company to build new student accommodation, typically to replace outdated accommodation stock or to meet unmet demand. The latter was the case on the Wollongong transaction. Universities typically specify the minimum number of new beds and required student mix based on a demand study commissioned by the university and made available to bidders.

For the most part, construction risks on student accommodation transactions are allocated in much the same way as on social infrastructure PPPs and the same types of risk issues are typically encountered, such as site condition, contamination and defect risk. How the market responds to such issues often depends on the amount of due diligence material made available to bidders (for example, geo-technical reports and contamination surveys) and the extent to which the market is given an opportunity to undertake its own due diligence on the proposed new student accommodation sites – a practical issue for the universities to manage is access around student semesters.

The approach to planning risk in Australia can differ markedly between transactions and is typically influenced by jurisdictional requirements or State-specific planning regimes (for example, in Victoria “public use” zoning can make planning risk an easier risk to negotiate than in other States). Like PPPs, standard practice is to require the project company to obtain all other relevant approvals. Depending on the location of the new student accommodation, this may include approvals such as bushfire overlays, which are likely to be an issue in more rural campuses.

Similar to the approach taken on education PPPs, in developing construction timetables and setting target completion dates, the parties will need to be mindful of academic timetables and time frames for allocating students to residences before the commencement of each academic year. Where existing residences are to be replaced by new student accommodation, the decant of students from one residence to another will also need to be factored in to avoid unnecessary disturbance to students and to minimise periods where student rents are not being received by the university or the project company.

The project company will be incentivised to meet target completion dates to maximise the amount of rental proceeds it will receive during the contractual term. Nevertheless, regimes will also need to be developed to cater for late construction completion and to include defect liability periods (potentially backed by defect bonding granted in favour of the university). On student accommodation transactions, late completion is a critical issue as alternative accommodation will need to be provided to affected students. The cost of providing alternative accommodation is typically met by the project company which will need to understand from the university what contingency plans it normally has in place (e.g. use of available beds at nearby establishments).

UK perspective: in the UK we would typically expect to see a construction support package that may well include a performance bond which could continue through the defects rectification period but it would be in favour of the project company and not the university.

Inclusion of existing accommodation

A feature of the current wave of student accommodation transactions (including Wollongong and ANU) is for the university to monetise the revenues flowing from the university’s existing student accommodation portfolio over the term of the concession period, in return for an up-front payment. However, to extract maximum value from this element of the transaction, it is essential that relevant existing student accommodation facilities have a residual life of at least the length of the proposed concession period. To achieve this, the university may require the project company to undertake and fund up-front refurbishment works to bring existing student accommodation up to the required condition standard.

Universities typically try to transfer to the project company as much latent defect risk for existing student accomodation facilities as possible. However, this risk allocation is often hotly debated – the project company will usually “price” the latent defect risk and this will affect the amount of the up-front payment that the university will receive. Universities can take steps to try to mitigate the project company’s concerns by commissioning condition surveys and allowing the project company to rely on the survey reports. Universities may also allow bidders to undertake their own “on site” due diligence of the relevant student accommodation facilities.

On some recent transactions (e.g. Wollongong), universities have recognised that some existing student accommodation facilities only have a short residual life and it therefore does not offer value for money to require the project company to undertake extensive refurbishment works. Instead, the university may stipulate at the outset of the transaction that a particular student accommodation facility will be excluded from the transaction at an agreed point in time so any refurbishment requirement can be scoped appropriately.

Scope of services

The practice that has been followed on recent student accommodation transactions (e.g. Wollongong and ANU) is for the project company to provide the Hard FM services to new and existing residences, with the university continuing to be responsible for the Soft FM services. However, the split between what constitutes Hard FM or Soft FM services can differ quite markedly between transactions and is often influenced by the importance that a university places on providing a “student experience” to its students or the extent to which the university wishes to outsource services to the private sector. Given the limited number of participants in the Australian market who are capable of providing “pastoral care” and other Soft FM services to students, the market preference is generally for the university to provide the Soft FM services (or to outsource it to a third party during the contractual term but to still be at risk for it under its contractual relationship with the project company).

If a university retains responsibility for providing Soft FM services, the manner in which it does this can have a significant impact on the quantum of revenue that flows to the project company. In particular, marketing of student accommodation and allocation of beds are key areas of focus. Recent transactions have managed this interface by requiring the university to comply with a Soft FM service specification and by developing a bespoke Key Performance Indicators (KPI) regime to measure the university’s performance against agreed criteria. Taking its lead from abatement regimes that are a common feature of PPP deals, the Wollongong transaction also introduced a “student rent” retention regime to incentivise the university to perform its retained services to the required standard. Sub-standard performance can result in the university paying amounts to the project company which are only reimbursed once the university has remedied the underlying issue: the key difference when compared to a normal PPP abatement regime is that the university does not forego the money provided it effects a remedy, so the issue becomes principally one of cash flow timing.

The project company’s provision of its services will also be measured against an output specification and relevant KPIs. A reciprocal retention regime has also featured on recent transactions. Following the approach taken on PPPs, it is also usual practice for default and termination events to be included in the project documents as another means for the university to incentivise appropriate performance by the project company.

UK perspective: UK student accommodation projects do not typically include a deduction regime for poor performance although there would typically be a performance points mechanism which could ultimately lead to termination for poor performance.

Demand and occupancy

The student accommodation market in Australia has recorded strong growth in the last decade, attracting international and domestic capital to what is regarded as a long-term and steady asset class. A range of factors can influence demand for student accommodation at a university, including:

• the university’s location, standing and reputation;
• the academic courses available;
• increases or decreases in the number of international students studying in Australia (principally students from Asia);
• affordability;
• supply of competing residential accommodation;
• proximity to the university; and
• the pastoral care and additional facilities available at purpose-built student accommodation.

In the Australian market, establishing satisfactory levels of demand for student accommodation is critical to fostering lender comfort and maximising bidding interest. Usually, the university undertakes an extensive due diligence process, prior to approaching the market, gathering relevant data and preparing a demand report. However, determining levels of demand with any certainty in the medium to long term is very much an art rather than a science. Each university will also have its own unique features which impact on existing and future demand for its student accommodation.

Equally important is providing evidence of strong historical and current occupancy. In the Australian market, the provision of direct or indirect occupancy support by the university can facilitate higher gearing, help optimise internal rates of return for equity and, as a consequence, result in a larger up-front payment to the university, even where prospective demand is less certain. Occupancy support is also seen by the private sector as a mechanism for incentivising the university to try to achieve maximum occupancy over the term of the transaction.

An example of direct occupancy support is the subsidisation by the university of student rent where occupancy levels dip below an agreed percentage or within agreed parameters. To maximise the up-front payment, the occupancy support level selected may seek to cover senior debt, with equity taking risk above that level.

Forms of indirect support vary across transactions and include, for example:

• protection around the treatment of the university’s student accommodation outside of the transaction (for example, controls on the accommodation applications process and amounts of student rents charged at those residences);
• right of first offer or refusal in respect of the finance, construction and inclusion in the transaction of new student accommodation at the university;
• accommodation guarantees offered by the university to certain categories of students; and
• strict controls over Soft FM activities which impact on occupancy, such as marketing of the student accommodation. As mentioned above, this may include detailed KPIs applying to marketing activities, with obligations around minimum marketing spend and regular marketing planning and reporting. The project company may also seek retention amounts, as discussed above, and ultimately step-in rights to take over the marketing itself if marketing KPIs are not being met.

UK perspective: many UK transactions will include some or all of the above terms of indirect support. It is common in the UK market to include a requirement for certain specified tests (e.g. in relation to historic and projected future occupancy levels and demand) to be passed before the university can build or take on any further new student accommodation.

Whether or not occupancy support is offered is a balance between the contingent financial exposure to the university, the need to attract investors (and, just as importantly, lenders), maximising the up-front payment and the impact on other elements of the transaction, such as the “off balance sheet” assessment.

Revenue and value

As noted above, an up-front payment is usually made to the university for the right to receive the student rental income stream flowing from the student accommodation included in the transaction. In order to procure funding for the transaction, the project company will require a high level of certainty regarding the levels of this income over the entire term of the transaction. On the other hand, the university will typically want to ensure that student rents cannot be increased in a manner which might damage its reputation, or its relationship with its students. Both parties have an interest in ensuring that student rents are set at a level which facilitates high occupancy of the residences.

The necessary certainty can be achieved by ensuring that the student rent adjustment mechanisms are objective (i.e. the amounts of student rents are not controlled by the university or by the project company) and are generally in line with the expectations of students occupying the residences, without unexpected significant increases occurring at any time. The mechanism may involve adjustments linked to the Australia Consumer Price Index, fixed percentages or market rates (or a combination of these). The student rental amounts may also be locked in for the first year or first few years of the transaction. Depending on the location of the university and other relevant factors, there could be difficulties in benchmarking student accommodation rental amounts against the “market” (e.g. little comparable private sector accommodation) and, for this reason, other means of adjustment may be preferred.

UK perspective: rent increases in UK student accommodation projects are usually linked to the Retail Prices Index, often with a cap and collar and usually with a set of agreed factors which can lead to additional adjustments to the rents to mitigate increases in certain costs of the project company. In some projects rents can also be benchmarked against other equivalent accommodation in the market.

Additional value can be derived by increasing the minimum number of weeks students have to commit to in the student accommodation agreements, although this is a sensitive issue for the student population and needs to be carefully handled.

It is also important to ensure that the student rent adjustment mechanisms in Australian transactions are capped where necessary; for example, to account for certain Goods and Services Tax exemptions applying to student rents and the statutory requirements applicable to student rents, the subject of the National Rental Affordability Scheme (a government scheme incentivising the provision of affordable accommodation which some universities have been able to take advantage of).

While student rent is the primary form of revenue in student accommodation transactions, other revenue to be included in a student accommodation transaction will depend on the preference of the university and the value that can be derived from such income. In addition to student rent, revenues can also derive from:

• a range of fees and charges associated with the accommodation and paid by the students (such as charges for utilities and internet usage);
• commercial income derived from the residences (car parking, cafes, laundry services, etc.); and
• income from use of the accommodation outside of the academic terms, including for conferences, school groups and short-term stays.

Conclusion

The student accommodation sector in Australia is here to stay for the foreseeable future, as there are a number of universities in the market for such deals or who are contemplating them. Competition for these transactions is strong with the potential for long term cash flows, the possibility of participating in further expansion of the university’s student accommodation and the more general opportunity of partnering leading education establishments proving particularly attractive.

For universities this type of transaction offers access to capital beyond the more traditional debt solution, capital which can be used to fund other projects within the university which might otherwise not be possible due to capital constraints. For students, the benefits are significantly improved accommodation and related amenities which contribute to an enhanced student experience, provided rents are maintained at affordable levels.

The scale and complexity of the transactions coming to market should not be underestimated, however, and so the sector demands real commitment from investors and their lenders if they are to properly understand it: as this article demonstrates, an understanding of “standard” availability-based PPP deals will only get investors so far. They need to understand both the micro factors relevant to the actual accommodation, along with macro factors such as student demographics, local and international academic competition and the future of tertiary education more generally. Provided investors are willing to invest the time to do this, the sector offers a potential pipeline of deals and a chance to play a role in shaping the landscape of Australian tertiary education.

UK perspective: in the UK market the current trend is for universities to develop accommodation to attract foreign students. Since domestic students are now also paying tuition fees, students on the whole are more discerning about what they get for their money. It remains to be seen whether Brexit will have an impact on the attraction of the UK for foreign students.