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Student housing gets good investment grades

Images of crushed beer cans and empty pizza boxes aside, a growing shortage in student housing has private investors and even financial firms heading back to school for investment returns.
A bedroom in the University Village at Raleigh condominium complex near North Carolina State University is seen in this photo from real estate developer The Priess Company. Residents of the 3 bedroom, 3 bathroom units also have access to a clubhouse with a game room and an outdoor pool.
A bedroom in the University Village at Raleigh condominium complex near North Carolina State University is seen in this photo from real estate developer The Priess Company. Residents of the 3 bedroom, 3 bathroom units also have access to a clubhouse with a game room and an outdoor pool.The Preiss Co.
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Images of crushed beer cans and empty pizza boxes aside, a growing shortage in student housing has private investors and even financial firms heading back to school for investment returns.

According to Michael Zaransky, co-CEO of Prime Property Investors based in Northbrook, Ill., and author of Profit by Investing in Student Housing: Cash In On the Campus Housing Shortage, the opportunity has staying power. “About 80 million 'echo boomers' will turn eighteen over the next ten years,” he says.  As they do, they will head to college in record numbers, further straining their chosen school’s already stretched budgets, especially if it is a public university.

“After funding enrollment, research, and hiring more professors, there is not enough money left for building dorms,” explains Donna Preiss, founder and CEO of The Preiss Company, which rents, manages and develops investor-funded student housing. This is why many schools are relying on the private market to supply off-campus housing instead.

“At Purdue, they tore down the older dorms and are busy building classroom facilities. Yet, they say this fall’s incoming class is the largest,’ says Pam Howard a co-owner of Livesay Property Management in West Lafayette, Ind.

That is a good thing for Howard and her husband who own a rental building close to campus. “So far, our building has been a very good investment,’ adds Howard, whose business —managing student housing investments for other owners — is also thriving as students scramble to find a place to live.

Not only is full occupancy typical for student housing, says Zaransky, so is the ability to increase rents.  The students show up regardless of local unemployment or interest rate levels, and they pay the going rate since they have to live somewhere — besides adding roommates can keep even increased rents affordable.

That this niche operates primarily on supply and demand is its key attraction to investors. Also key is its positive cash flow despite hefty expenses — real estate taxes, high insurance premiums (reflective of the reputation of student renters), utilities, repair, maintenance, advertising and fees for management services.

But not all college towns or investment opportunities are created equal.  Like any investment, selecting a property requires some homework.

Location, Location, Location
The best properties are within walking distance of a campus, says Zaransky. They are also located where the kids are increasingly choosing to go to school.

“The southeastern and southwestern states especially draw the most kids,” says Preiss, who notes the northeastern schools are more likely to institute enrollment caps which limits their attractiveness to investors.

Zaransky also warns against going where rental properties are already abundant, as in large urban areas like Chicago and New York, especially after the recent run up in property prices there.  “The odds tip in an investor’s favor with moves to pure college towns,” he adds, noting that Boston is the exception to this.

To help identify prime campuses, Zaransky uses a ratio to relate the number of university-owned beds to enrollment, using data mined from registrars’ offices.  “Nationally, this ratio averages about 30 percent,” he reports.  But it varies widely. At Arizona State University, for instance, he estimates the ratio to be 11 percent meaning 89 percent of ASU students are renting off-campus.

That imbalance is precisely what Rick Steele, a Denver businessman is looking for.  His son will be attending ASU this fall and Steele intends to invest in a condo for him.

This is not Steele’s first attempt at making a student housing investment.  He wanted to buy property when his older son was in school in Providence, R.I.  But that market seemed to offer minimal price appreciation and most of the available property involved older boarding houses.  “It did not make financial sense since they were in need of so much maintenance and repair,” says Steele, who opted to pay rent instead.

He finds the Phoenix/Tempe market much more hospitable. “It is so vibrant and the housing stock is newer,” he says.  Newer is better for today’s students, who prefer buildings with pools and saunas and view wireless Internet connections as an essential.  Preiss, for example, builds her units with bedroom-to-bathroom parity so roommates do not have to share facilities. 

“I figure with what I would pay for a dorm or fraternity, at worse I may breakeven when I sell. If the property appreciates, then it will help offset the education cost,” says Steele, adding “Either way, at least my son will have a nice place to live while he is there.”  Steele’s attitude is a good one and realistic for parents who only expect to hold their ‘kiddie condos’ for three-to-five years.

“It is really too short a period of time to realize enough of a return after the expense of holding and then selling to make it worthwhile,” says Stuart Tsujimoto, a certified financial planner with the Financial Network in Torrance, CA. He speaks from experience, having bought a condo for his daughter while she attended San Diego State University.

Tsujimoto, who bought the condo outright rather than mortgaging it, feels that after factoring in his expenses plus the realtor’s commission when he sold, he would have made roughly the same return on his money by investing in a mutual fund and making withdrawals to pay for rent.

But for those who intend to buy and hold after graduation, the experience seems to be more positive. Tim Hinz, a realtor with Keller Williams in San Diego has had a number of clients buy condos for their college-bound kids.  “So far everyone who did, held onto it or gave it to the child who assumed the mortgage payments after graduation.”   Many, given the particulars of the area, may also be holding for a retirement use later on in life.

Preiss also says most of her clients view their student condos as long-term investments. Even her parent-buyers tend to hold after realizing how attractive the cash flow is. They simply have her, as the property manger, rent out the freed-up ‘bed’ once their child moves on. In Preiss’s developments as in others, leases are written by the bed or directly with each roommate, removing the legal onus of having to enforce a lease from parents, investors or owner-students.

While buying a ‘kiddie condo’ can be advantageous versus paying rent or the dorm expense, especially if a parent can access a Federal Housing Administration program to help finance it. Dubbed the "Kiddie Condo Loan," the program allows students — and non-students — to purchase a home with an assist from a blood-relative’s good credit standing and cash.  The home must be considered the primary residence of at least one of the borrowers, but renting out space to roommates is allowed. If the child moves out after graduation, the borrowers would have to refinance or sell the property to pay off the FHA mortgage.

These loans only require 3 percent down and since they are considered owner-occupied, they qualify for all the tax advantages of a primary residence; whereas a condo purchased as a second home or investment property may limit the tax breaks and raise the interest rate offered.

In addition to not having to deal with dorm-life, the owner-child benefits from building a credit history, having a place to live, and potentially assuming the responsibility of being a landlord to their roommates.

Despite those financial incentives, Zaransky advises parents not to feel obligated to invest where a child is attending school.  Actually, he sees no reason to link the investment to a child at all.

“It just needs to be a good investment — rents need to be rising in the area you choose, and there should be an opportunity for appreciation over time. If those factors are not present at a child’s university, then parents should invest in another town and pay rent for their child’s housing instead,” he says.

For those who cannot swing the purchase of a condo or multi-unit building as an investment, there is another option for cashing in on the student housing shortage.  There are actually three publicly traded Real Estate Investment Trusts that focus on student housing. Each offers a generous dividend yield and allows shareholders to participate without having to deal with the responsibilities of ownership.  They are:

  • American Campus Communities (Symbol: ACC)
  • Education Realty Trust (EDR)
  • GMH Communities Trust (GCT)

Regardless of how one chooses to invest, with growing demand for housing outstripping its supply, the investment returns are expected to continue far longer than the four-to-five years a child spends in college.